The Little Guy in China Faces a Funding Squeeze

China has sought to promote small companies, typically the engines of job growth, while simultaneously curbing financial risks. It turns out that it may be hard to do both at the same time.

With a second year of concerted efforts to rein in leverage getting under way, the nation’s smaller companies are seen as the most at risk. While they enjoyed solid loan growth in 2017, borrowing costs are likely to rise this year, and the bond market offers little respite. Larger firms are relatively shielded because they have better access to funding from dominant state-owned banks, which face less pressure from the curbs.

China’s focus has been wringing out funding that goes toward speculation and chasing asset bubbles -- and indeed, data show that the country is now getting more bang for its credit buck. The trouble is, it’s also likely to damp growth of one of the most vibrant parts of the economy, hindering efforts to tackle inequality. Official manufacturing gauges show the gap between small and large enterprises has been widening since mid-2017.

“Containing financial risks will remain a top priority this year, so credit conditions of smaller firms won’t improve fundamentally -- unless regulators roll out more targeted policies to help,” said Shen Lan, a Beijing-based economist at Standard Chartered Plc who oversees a monthly survey of more than 500 small and medium enterprises. "Lending to smaller companies is the first to be squeezed," she said.

Feeling Pain

Investors may be anticipating the pain. A measure of small stocks is near the the lowest versus the nation’s listed giants in more than three years. The small-cap ChiNext Index is down about 5 percent over the past three months, while the CSI 300 Index of large companies has climbed almost 10 percent -- deepening a year-long divergence.

The new year has seen a fresh series of deleveraging measures, with regulators tightening oversight over entrusted bond holdings, leveraged bond trading and entrusted loans. There’s good reason to act, with debt at 264 percent of the economy and a shadow banking sector in excess of $4 trillion that’s prompted even the central bank chief to warn of the dangers of a sudden collapse in asset prices.

Read more: How China Is Getting Serious About Financial Risk: QuickTake Q&A

"Small and medium-sized companies will face higher pressure than the big ones in this round of interest-rate increase," said Liao Qiang, senior director of financial institutions at S&P Global Ratings in Beijing, referring to the repricing of loans amid tightening regulations.

The government hasn’t been ignorant of the challenges for SMEs. Along with giving them some tax breaks, a new banking measure is aimed at helping. Starting this month, banks that lend to these borrowers, and to agriculture, won’t need to hold as much cash in reserve.

That may not be enough. While helping SMEs get a credit is a challenge in most economies, in China, they can have an especially hard time competing against government-backed giants because financing still mostly comes from state-owned banks. 

"Smaller banks are the first to feel the shockwaves when regulators rein in interbank lending, which they depend heavily on," said Zhang Ming, the director of international investment research at Chinese Academy of Social Sciences, a state-backed think tank in Beijing. "Then they pass that crunch onto their clients, many of which are small companies."

And the so-called big four state banks are growing even stronger. Their stocks have rallied as investors bet on their comparative advantages with the crackdown on shadow banking. Their smaller, typically private, counterparts sold off in the new year as China left out smaller lenders from a measure that helps banks meet liquidity needs during Lunar New Year.

Another option for smaller companies -- direct financing through bond and equity sales -- hasn’t offered much promise. The deleveraging efforts have curbed demand for fixed-income securities, and equity financing has always been relatively minor. That all leaves the smaller fry less able to mop up surplus labor from a separate government initiative to streamline state-owned enterprises.

“Unless you have a really good-performing small-cap market, it’s hard to sell that dream to the public,” said Hao Hong, chief strategist at Bocom International Holdings Co. in Hong Kong.

— With assistance by Justina Lee, Xiaoqing Pi, and Alfred Liu