State Council Announces Financial Measures to Help SMEs

VAT and business tax thresholds to increase, but bad debt looks set to jump

China’s State Council announced measures yesterday to provide tax relief and financial easing towards the nations small-medium enterprises. Acknowledging that SME’s play a crucial “role in job creation and social harmony,” the measures are a timely response to a structural issue that has long plagued China – getting sufficient capital to smaller businesses. The steps taken include several initiatives as follows:

• Permitting low reserve requirements for smaller local banks lending to SMEs;
• Permitting greater use of bonds and other financial instruments by SMEs to raise cash;
• Raising VAT and business tax thresholds to SMEs;
• Providing improved financial services to SMEs.

“Currently some small and micro sized firms are facing operating difficulties and the problem is also that they are finding it hard to get finance, all of which we need to give high attention,” China’s State Council said in a statement issued yesterday.

At the same time, Beijing said it will crack down on loan sharks that have been offering loans to SMEs at high rates. China has seen a plethora of underground lenders charging borrowers interest rates at up to 100 percent.

There has been increasing criticism of China’s antiquated national banking structure, which is still archaic and geared to central planning and supporting SOEs rather than smaller capitalist ventures. The Chinese system is still largely dominated by huge banks, all of which cater for larger businesses only. In a nation of 1.3 billion, and the world’s second largest economy, China today still only has about 100 fully-licensed banks. The United States, by contrast, has a layer of community banks that assist local SMEs and startups. It is understood the State Council is looking at banking reform in this sector.

The measures are expected to be placed into effect towards the end of this year. Meanwhile, Credit Suisse has significantly raised its projections for the proportion of non-performing loans (NPLs) within Chinese banks from 4.5 – 5 percent to between 8–12 percent for the next five years. The report reflects growing credit risks in China in four main areas: real estate, manufacturing, local government debt, and SMEs.

The report is among the harshest issued by any banking analyst, and seems to confirm Beijing’s worries over the plight of China’s SMEs. Chinese media outlets have recently been full of stories of business owners running away from debts, particularly in East China. Many had invested money raised for their businesses and diverted it instead into real estate or the stock market, resulting in crashing losses and a business without working capital. Credit Suisse has highlighted the four areas stated as having the potential to create over 80 percent of China’s total NPLs.

Credit Suisse says that another round of bad debt is expected in China when loans made to local governments as a result of China’s emergency funding during the 2008 Global Financial Crisis become repayable. Currently, very few are booked as bad debt, however these amounts, known as LGFVs (local government financing vehicles) received the bulk of Central Government funding and are about to become due. Credit Suisse suggested that Chinese banks could lose as much as 40-60 percent of their equity if NPLs rise to 8-12 percent, with a return to normal market conditions in China not expected until 2015 – providing China takes “appropriate” measures to deal with the underlying asset quality issues still booked as recoverable.

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