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Roula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.
The writer is chief economist at Enodo Economics
Just how bad is the economic distress rippling through the Chinese economy? The bankruptcy of China’s largest private real estate group, Evergrande, has generated international attention. But the travails of China’s small and medium-sized enterprises are less documented, and now new rules designed to reduce risk are further stressing small borrowers that need credit to survive.
While companies such as Evergrande represent a risk because of their size — the group’s liabilities are estimated at $300bn — defaults by local firms reflect the breadth of the trouble in the Chinese economy, with SMEs providing 80 per cent of urban employment.
Beijing is aware of the liquidity plight of SMEs and does want China’s banks to lend to them more. But so far policymakers have not only failed to move the needle but have also focused on preventing risk at the expense of real economic activity by private sector firms. In short, what Beijing needs is to embrace private companies as part of the solution to what ails the Chinese economy — not part of the problem.
China’s small and private companies may not be household names outside their hometowns, but they are the life force of the Chinese economy, especially at the local level. In recent years, they have borne the brunt of the economic slowdown, the Covid lockdowns and the regulatory crackdown on private financing as well as lending to oversupplied industries.
The obstacles facing small businesses are evident at the micro level; for instance, in instruments known as bankers’ acceptance bills. Popular as a way to ensure smaller businesses get paid up front, the bills have evolved into a key channel for liquidity and credit in the past five years.
The bills are a commitment, by a bank, to pay a specified amount on behalf of a customer. They are commonly used in commercial transactions as a guarantee of payment, and in practice are often traded as fungible instruments.
They are popular among Chinese SMEs because they allow them to get paid earlier, easing cash flow and becoming one of their few reliable channels of financing. Over the past few years, as regulators shut off access to other traditional sources of financing, the bills became a way for SMEs to secure small-scale or short-term loans.
Now, new regulations have constricted this important financing channel. These reforms have sought to shore up the financial stability of regional banks by reducing abuse of these instruments. They include requiring bills to be based on “real transaction relationships” and making banks classify overdue acceptance bills as non-performing loans.
But they could have a broad, and probably unintended, negative economic impact. Starting at the beginning of this year, regulators limited banks’ ability to extend this financing to SMEs by restricting the maximum value of acceptance bills and reducing the payments period for new acceptance bills to six months. This heightens the pressure on commercial enterprises to pay within a shorter timeframe amid tightening cash flow.
The rules require the reporting of firms who have defaulted on bankers’ acceptance bills and of bank branches that fail to honour them. Failures to pay are recorded and published by the Shanghai Commercial Paper Exchange, which also maintains a separate list of repeat offenders.
Analysis of this new data series by my firm shows the problems rippling through SMEs in China. Defaults on bankers’ acceptance bills peaked in the second and third quarters last year.
The data also reveals that the pressures piling up on indebted local businesses are starting to bleed into banks as well. Hundreds of local bank branches defaulted on bankers’ acceptance bills in 2023, including outlets of some of the Big Four state-owned banks.
Individually, the companies tracked by the SHCPE data are just blips on the radar, but collectively they are a barometer for the health of local and regional economies.
These vulnerabilities remain as long as the real estate crisis and substantial credit losses weigh on China’s growth — and that will be a long time yet.
If Beijing maintains its risk aversion at the expense of the small companies that support the local and regional economy and does not find a way to channel more funding to them, we should expect to see more signs of a China slowdown emerge in 2024.
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