Workers assemble medical equipment in a manufacturing company in Wenzhou, Zhejiang Province. Photo: CHINA DAILY

---

 

The transformation of the private sector is key to promoting high-quality economic development. During his inspection tour of Guangdong in October 2018, Chinese President Xi Jinping stressed the private sector’s role in innovation and entrepreneurship and the inseparable role of the country’s small and medium-sized enterprises. He called on the government at all levels to work toward ensuring that the business environment provides the conditions for private enterprises to grow, especially small and medium-sized firms.

At present, the development of China’s private economy is facing three major dilemmas, involving market, financing and cost.

 

Three dilemmas
Since 2010, China’s economic growth has entered a downward trend. The growth rate has shifted from a high growth rate of over 10 percent to a medium growth rate of around 7 percent. The economic downturn has led to a slowdown or even a decline in domestic demand, which in turn has intensified market competition.

After the outbreak of the international financial crisis in 2008, the world economic growth slowed down significantly, taking a toll on China’s foreign trade. The annual growth rate of China’s foreign trade has dropped from more than 20 percent to about 10 percent. From July 2015 to December 2016, China’s foreign trade has experienced negative growth for 17 consecutive months.

Compared with large enterprises, in the face of the downward change in domestic and overseas markets, the private economy, especially small and medium-sized enterprises, has taken the hardest hit. In the Purchasing Managers’ Index (PMI), the reading for small and medium-sized enterprises has been significantly lower than that of large enterprises in the same period since 2012, and the reading for small enterprises has always been below the line marking expansion or contraction, indicating industry contraction and pessimism among purchasing managers.

Since 2010, the expansion rate of China’s financial cycle has slowed down, and the growth of the money supply and that of total social financing have also shown a downward trend. In particular, since 2017, the real economy has strived to reduce leverage, and the economy has taken on a new normal development. The financial system has also strengthened risk control and promoted deleveraging at every level. Liquidity has been sharply tightened, with money supply growth below 9 percent and total social financing slowing to less than 11 percent, both at historic lows.

Tighter monetary conditions have exacerbated the financing difficulties of the private sector. Due to the small scale, the lack of qualified mortgage guarantees, the relatively non-standard financial system and other reasons, small and medium-sized private enterprises have been struggling with difficult and expensive financing through bank credit.

In addition, the procyclicality of fiscal policy is prevalent. In the economic downturn cycle, especially in the context of financial deleveraging, the tightening of the monetary environment has increased the difficulty of financing for small and medium-sized private enterprises.

Since 2010, the RMB loan balance growth has had a downward trend, while medium-sized enterprises’ RMB loan balance during the same period of growth has been more downward, lower by 2–3 percentage points. In particular, from the third quarter of 2015 to the first quarter of 2017, the difference registered at 6–8 percentage points.

In terms of bond financing, the bond issuance of private enterprises in the first three quarters of 2018 was 402.9 billion yuan. This was 470.6 billion yuan less than in the same period of 2016 and 60.2 billion yuan less than that in 2017.

Since May 2017, the scale and market value of the investment funds privately raised by small and medium-sized enterprises have shown a downward trend. By September 2018, the number of bonds privately placed by small and medium-sized enterprises had been reduced by more than 300, with a decrease of more than 230 billion yuan in market value. The scale of private enterprise bond financing decreased significantly.

Compared with how it treats state-owned enterprises, the financial sector tends to tighten funds for private enterprises, constantly pushing up their credit spread. Since 2010, the credit spread of private enterprises has been on the rise, most of it fluctuating above 200.

Therefore, private enterprises tend to supplement current assets by reducing investment, further restricting the investment of small and medium-sized private enterprises. Since 2011, the growth rate of private investment has declined rapidly. The growth rate of private investment in urban fixed assets has dropped from more than 30 percent to less than 6 percent, and to only 3.2 percent in 2016. The rapid decline has led to a decline in the proportion of private investment in fixed asset investment in 2016 and 2017.

The third dilemma is rising costs. The government has launched intensive tax reduction policies under supply-side reform, especially since May 1, 2016, when the value-added tax replaced the business tax. This was considered the most significant transformation in China’s turnover tax system since the 1994 tax reform. However, the overall tax burden of Chinese enterprises is still high.

According to statistics by the World Bank, in 2017, corporate tax in China accounted for more than 80 percent of the total tax revenue, while corporate tax in the United States, Canada, Britain and Germany accounted for only 34 percent, 42 percent, 50 percent and 52 percent, respectively.

In 2017, the tax payment of Chinese enterprises accounted for more than 65 percent of the total profits, and the tax burden of Chinese enterprises was significantly higher than that of enterprises in major developed countries.

In addition, China’s current turnover tax-centered tax structure is extremely unfavorable to small and medium-sized private enterprises. Most private enterprises are in the middle and lower reaches of the industrial chain, and the tax burden of the upper reaches of the industrial chain can be transferred to the middle and lower reaches through price.

In recent years, China’s labor costs have been rising solidly. In 2010, the average annual salary of employees working in the urban private sector in China was 20,759 yuan, rising to 45,761 yuan in 2017, with an average annual increase of 11.9 percent.

Rising housing prices are also driving up rent for factories and office buildings. This is coupled with the increasing burden of social insurance premiums, piling up the operating costs of private enterprises.

Under the pressures of the market, financing and cost, the overall operating environment for the private economy is deteriorating and the profitability of private enterprises is declining.

The Small and Medium-Sized Enterprise Board and Growth Enterprise Market listed companies are miniature private enterprises. Since 2009, the return on net assets of the companies listed on these boards has shown a significant downward trend, from 13.1 percent and 9.4 percent in 2009 to 8.9 percent and 6.1 percent in 2016.

Since 2017, the growth rate of the industrial added value of small and medium-sized enterprises has been continuously lower than that of enterprises above a designated size in the same period.

 

Policy advice
In this critical period as China’s economy turns to high-quality development, it is essential to remove obstacles in the development of the private sector and enhance the development ability of the private economy. To save private enterprises from the aforementioned dilemmas, we need to take swift, targeted and vigorous measures.

To start with, the measures should be fast and avoid the aggregation of risks. In the first three quarters of 2018, 24 out of the 29 enterprises that defaulted on their bonds were private enterprises, involving 67.406 billion yuan. As China’s economy follows an L-shaped path and tightened financial supervision, private enterprises will continue to face increasing debt repayment pressure in the future, which may lead to more credit default.

The soaring scale of equity pledges since 2015 has gradually increased the number of companies whose equity pledge has fallen below the market value of the closing position due to the downward trend of the A-share market, and the risk for equity pledges has continuously increased.

According to data from China Securities Depository and Clearing Corporation Limited, as of Nov. 14, 2018, there were 644.43 billion shares pledged in the market, with the number of shares pledged in the market accounting for 10 percent of the total share capital and the market value of the pledged shares being 4.541 trillion yuan.

The total unliquidated market value of the major shareholders is 1.319 trillion yuan, and the major shareholders are suspected to have reached the liquidated market value of 300.1 billion yuan. The government needs to quickly put forward relevant measures to ease the private economy stock pledge risk.

Given the market predicament of private enterprises, it is necessary to expand the domestic demand and create a fair competition environment in regard to market access, examination and approval, operation, bidding, and other aspects. The implementation of export tax rebates, trade financing and facilitation measures will also help improve the environment for the development of private enterprises.

For the financing difficulties of private enterprises, efforts should be made in both direct financing and indirect financing to reduce the listing threshold for small and medium-sized private enterprises and innovative enterprises. High-quality private enterprises might be allowed to issue bonds for financing to increase the proportion of direct financing.

Other measures such as lowering the relending rate, reducing or exempting service charges, implementing differentiated credit policies, and channeling new credit funds will also help reduce the financing costs of private enterprises.

For the development of the private economy, a variety of policy measures need to work together to fundamentally reverse the adversity and achieve healthy and stable development.
Tax reduction and fee reduction, for example, could directly increase the internal surplus of enterprises, directly alleviating the operating pressure and improving the profitability and investment ability of private enterprises.

Therefore, the scale of tax reduction and fee reduction should be greater. Existing preferential tax policies should be implemented at a larger scale, and substantive and inclusive tax reduction policy should be introduced. At the same time, a variety of administrative fees should also be cut down to effectively reduce the burden on private enterprises.

 

He Chengying and Yang Gaoyu are from the Research and Development Department at Guosen Securities

​(edited by YANG XUE)