The plight of Chinese small- and medium-sized enterprises (SMEs) may be old news, but recently their prospects have worsened. Their already-thin margins are being crushed by intensifying competition, high commodity prices and skyrocketing wages. Now the central government’s attempts to slow down the economy by restricting credit growth are making it even more difficult to get loans to keep operations afloat. These factors, combined with downward trends in the export sector, have lead many pundits to forecast a “wave of bankruptcies” for ¬Chinese SMEs.
In fact, some say the wave is already underway. Zhou Dewen, head of the trade ¬association for SMEs in the famed entrepreneurial hothouse of ¬Wenzhou, made ¬headlines when he claimed that nearly one-fifth of the city’s SMEs were at risk of going bankrupt. Zhou expects that figure to increase to 40% by the next Chinese New Year.
Outsize influence
A crisis among SMEs would have serious macroeconomic implications; they generate about 60% of GDP and employ two-thirds of Chinese workers. But it remains difficult to verify Zhou’s figures, or anyone else’s.
While various ministries have produced statistics that show SMEs are doing fine, Victor Shih, a political economist at Northwestern University, pointed out that the National Bureau of Statistics’ definition for “large enterprises” was recently revised upward from RMB5 million in revenue per year to RMB20 million, banishing untold numbers of Chinese companies from many statistical surveys: “We cannot rely on the statistics any more. Anecdotally, SMEs are suffering, and I tend to believe it,” he said in a written response to questions.
Put in context, of course, SMEs are always suffering. In the US, about half of small businesses vanish within the first five years of being founded, many due to bankruptcy. “Small private companies go bankrupt all the time, in China as in other markets,” said Andy Rothman, chief China macro strategist at CLSA. He said CLSA regularly surveys a group of SMEs across the country, and only around 6% of them said that more SMEs had gone bankrupt in their area than usual.
Under-leveraged
While the general understanding of the health of China’s SMEs remains murky, it is undeniable that access to credit is a challenge for ¬most Chinese private firms – and not just the small ones. “For [Chinese] public sector firms, the leverage ratio is eight to one. For private listed firms, it’s four to one,” said Frank Yu, professor of finance at China Europe International Business School (CEIBS). “That’s pretty ¬constrained.”
“The companies we invest in definitely need more money, and they need the lowest cost of capital possible,” said Chauncey Shey, executive managing director at SB China Venture Capital.
Yu of CEIBS also noted that better access to credit can encourage state-owned enterprises (SOEs) to enter new markets and crowd out the private sector: “If [SMEs] have access to loans maybe they can go out and expand, but if they don’t, the state-owned firms can step in.”
Some argue that this crowding-out effect is, in fact, a tacit policy goal. After all, this is a communist government, and Party leadership has repeatedly and clearly stated that it intends to preserve an economic leadership role for the state, and by extension state firms.
But Beijing does not want to destroy the private sector, and politicians certainly don’t want to be blamed for a policy-induced “wave of bankruptcies.” Even so, helping SMEs is tricky. Like the small farmer, the small businessman is a sentimentally popular figure. But he is also a risky man to lend to. His business is unstable, he lacks collateral, and his reputation for innovation – if one excludes inventing schemes to evade regulations – is almost certainly exaggerated. Thus state-owned banks have been reluctant to lend to SMEs, despite frequent urging from the central government. Meanwhile, policy-backed support for SMEs like micro-loans and subsidies – neither of which has been a panacea in other economies – have proven clunky to implement here.
What has worked best in China so far has been the country’s trillion-dollar “back-alley” banking system, with channels ranging from the semi-legal to the criminal: friends and family, loan sharks, domestic private equity funds, and illicit loans from cash-sodden SOEs looking to get a higher return on their savings.
Since many of these ventures are semi-legal at best, they have come under fire from Beijing. Vice Premier Wang Qishan recently called for a crackdown on “illegal financial activities,” which some read as targeting back-alley banks.
But while shutting down loan sharks is politically popular, such parasites stay in business because they meet a genuine demand. Such a campaign, however morally satisfying, threatens to damage a critical, if expensive, funding mechanism for high-risk enterprises.
There is one solution. Business demand for hybrid products like the Alibaba Group’s AliLoan program, which doled out around US$3.75 billion in credit to small businesses (in cooperation with partner banks) last year, has boomed in this environment.
There is plenty of innovation in the works. “We are seeing a major surge [in lending] from the private sector,” said Shey of SB China Venture Capital.
“Private capital is enough to tackle the problem in Wenzhou,” said Hu Minghuan, a manager at Wenzhou HEC Fashion International. “Wenzhou companies have accumulated lots of it.”
The best policy, perhaps, would be to cut back on loans to the inefficient but well-connected state champions and leave the SMEs to fend for themselves.