Impacts of the Current Financial Crisis on SMEs in the People's Republic of China

3.1 State of Continuous Development of SMEs in the PRC from 2005 to 2008

The PRC's private enterprises have maintained a relatively high growth rate. With the commencement of industrial upgrading and transformation after 2005, the number of enterprises, people employed, registered capital, and export growth began to show a mild downward trend. However, in 2007 an obvious inflexion appeared. This was because the central government promulgated a series of macroeconomic policies to reign in inflation. For instance, the People's Bank of China, the PRC's central bank, up-adjusted the deposit and loan interest rates on four occasions and up-adjusted the required reserve ratio six times. The rate of export rebates for enterprises with high-energy consumption, high pollution, or low addition values was also reduced or abolished. All of these factors greatly increased the operating costs of enterprises. Main indicators for the SME growth rate from January 2008 to May 2008 showed a relatively big downslide (as shown in Figure 7 [ PDF 51.1KB | 1 page ]). However, the ratio of SMEs' exports to the PRC's exports as whole remained in an upward trend.

Figure 8: Growth Rate of Related Economic Index of Micro-Small Private Enterprises in the PRC (%) 2005–2008 [ PDF 45KB | 1 page ]

Figure 9: Export Growth Rate of Small and Medium Private Enterprises 2005–2008 (%) [ PDF 45KB | 1 page ]

3.2 The Current Financial Crisis Caused Severe Impacts on the PRC Economy

Catalyzed by the sub-prime mortgage crisis in the United States (US), the global financial crisis broke out in September 2008, having serious impacts on the PRC economy.

One impact was that GDP growth declined dramatically. According to statistical data from National Bureau of Statistics (NBS), the GDP growth rate in 2007 was 11.9% and quickly dropped to 9.0% in 2008. GDP grew at 6.1% in the first quarter of 2009, the worst performance in the PRC economy since 2002.

The financial crisis also caused export growth to drop sharply. In 2007, the PRC's exports increased 23.5% over the previous year. In 2008, the PRC's imports and exports in foreign trade totaled US$2.56 trillion , an increase of 17.8% year on year. However, the export growth rate in December 2008 was -2.8%, the first of its kind in 10 years.

In the meantime, the rising unemployment rate tightened the liquidity of funds throughout the PRC, especially impacting export-oriented SMEs (Li 2008). To some extent, this damaged the PRC's foundation for its economic development.

Figure 10: Real Growth Rate of GDP in the PRC (%) [ PDF 54.6KB | 1 page ]

Figure 11: Growth Rate of the Consume Price Index (CPI) and the Producer Price Index (PPI) [ PDF 54.6KB | 1 page ]

Figure 12: Export Growth Rate of All Types of Enterprises (%) [ PDF 47.9KB | 1 page ]

Figure 13: Export Ratio of All Types of Enterprises (%) [ PDF 47.9KB | 1 page ]

3.3 Impacts of the Current Financial Crisis on the PRC's SMEs

The current financial crisis has had two big impacts on SMEs in the PRC. The crisis has resulted in a sharply decreasing external need for export-oriented SMEs and more severe financial difficulties for all SMEs overall.

3.3.1 Sharp Decreasing External Need for Export-Oriented SMEs

As the crisis unfolded, deflation appeared in the world economy, directly causing a dramatic contraction of the international products markets. Beginning in November 2008, both imports and exports in the PRC declined year on year and showed negative growth. Enterprises producing daily necessities such as toys, clothing, textile products, shoes, furniture, sports gears, and stationeries were most affected, with the east coastal region being hit most severely. Most of the enterprises that were forced to shutdown were export-oriented SMEs.

The biggest problem currently facing export-oriented SMEs is insufficient market demand (Li 2005). In January 2009, the number of orders received by these SMEs dropped by 20–30% year on year, with some orders declining by as much as 50%. In addition to the reduction in new orders, there were also many suspensions and cancellations of contractual export orders. From January 2009 to February 2009 the cumulative realized values of goods exported and shipped by industrial SMEs with annual sales of over CNY5 million in Zhejiang Province was CNY82.8 billion, a decrease of 17.09% year on year. The ratio of export value to the sales production value of industrial SMEs with annual sales of over CNY5 million also declined to the low level of 22.8%. In January 2009, a questionnaire administered by the Bureau of Trade and Economy in Shenzhen surveying enterprises in the area revealed that 52.5% incurred a reduction orders. In January and February of the same year, the number of orders received by enterprises in Sichuan and Shanxi Provinces dropped greatly, sometimes even to nothing, and the possibility of reduced production, ceased production, and shutdown was imminent for many.

Because the import demand for PRC commodities from the European and US markets shrank dramatically, export-oriented SMEs felt the impacts of reduced orders and slow production. Many SMEs chose to limit or cease production and narrow their product lines. Export-related difficulties such as reduced international orders, increased trade risks, difficulty in recalling funds, and rapidly declining profits directly contributed to a severe contraction of market demand in relevant upstream domestic industrial chains, exacerbating the deterioration of the domestic economy. Consequently, some of the export-oriented SMEs began to turn to domestic market development. However, domestic market development takes a long time, requiring the building of brands and opening up of domestic market channels (Ding 2001). Thus, due to sluggish internal demand, it proved difficult for these enterprises to divert from international to domestic markets.

The global financial crisis had strong impacts on export-oriented enterprises along the eastern coast of the PRC, resulting in ceased production, business suspension, and even shutdown of a large number of enterprises. According to the sampling survey, by the end of 2008 SMEs along the coast that suspended business, ceased production, or were shutdown accounted for around 7.5% of troubled enterprises in the country (Li 2008). According to a research report on SMEs by the Chinese Academy of Social Sciences (Chen 2009), by the second half of 2008 67,000 SMEs had ceased production around the country. By the end of 2008, over 100,000 enterprises had ceased production. Except for those that had changed products or locations, the rest of the enterprises had to shutdown and accounted for over 60% (about 60,000) of all enterprises on the eastern coast. For these enterprises, their current task is to figure out how to survive.

There are 130 million migrant workers being employed in urban areas. Due to the ceased production, business suspension, and shutdown of many SMEs in 2008, approximately 20 million migrant workers (accounting for 15.3% of the entire migrant work force) lost their jobs and returned to rural areas. Statistics showed that the number of employed people in the first quarter of 2009 dropped by 5% (Chen 2009).

3.3.2 More Severe Financial Difficulties

The economic trend for 2009 is still unclear. Many entrepreneurs are not optimistic about the expected market demand. They worry about the future of their corporate development and are not confident about the growth of the industrial economy (Jiang 2006). Some entrepreneurs are frustrated by investment markets and are cautious about entering the market; in some cases, entrepreneurs have even withdrawn their investments from the market. Since the inception of the financial crisis, pressure for SME sales has constantly increased, with large sums of working capital backed up in production, increasing account receivables, and stagnant inventories. For production to return to its original scale, enterprises need more turnover funds, exacerbating SMEs' funding shortage. Delayed payment between enterprises has resulted in tight cash flows, which is compounded by the fact that most SMEs are unable to obtain new loans from banks.

In order to boost internal demand, the government has designed an investment plan of CNY4 trillion to stimulate economy in 2009 and 2010. The funds are mainly being channeled to key projects such as railways, highways, and infrastructure. However, SMEs will receive little benefit from this investment, though some of them may indirectly benefit through project subcontracting, which takes a long time and is not usually felt over the short run.² In 2009, despite a larger increase of loan issuance by banks there has not been much capital flowing to SMEs. In January 2009, national credit amounted to CNY162 million and was mainly used in energy, transportation, and infrastructure projects. Loans for small enterprises accounted for only 5%.

Most development funding for the PRC's SMEs comes from the capital of business owners and their internal retained profits, which are maintained at levels over 50–60%. Direct financing, such as corporate bonds and equity financing, accounts for less than 1% and bank loans account for around 20%. Because indirect financing is the main form of financing for the PRC's SMEs, it is difficult to determine the financing risk of SMEs. A lack of standards, poor laws and regulations, and serious creditability problems for SMEs has made access to the domestic financing market for SMEs more difficult than for public companies. Over 70% of short-term funds for all private enterprises will have to rely upon credit and loans from non-governmental sources. However, as the performance of even the best SMEs suffers due to operational difficulties, more SMEs worry about making loan payments and lack the confidence to borrow funds from non-governmental sources. As a result, formerly vigorous non-governmental financing has shrunk conspicuously and SMEs' access chains to funds are on the verge of being broken. The current financial crisis has exacerbated the difficulty of securing financing for the PRC's SMEs.

The cost of enterprises began to rise during the second half of 2007. Since the onset of global financial crisis, the situation has become more severe. The crisis has dramatically increased the financing costs from SMEs. Since September 2008, although the government lowered the benchmark interest rates for banks, quite a few banks have still up-floated 20–60% over the benchmark interest rates for SMEs loans in situations where a guarantee has been implemented. Some banks also charge corporate caution money or financial advisory fees. In 2008, the financial fees for industrial SMEs sales in Zhejiang Province with over CNY5 million in annual increased 26.9%, while interest increased 32.0% year on year. Some banks would even ask enterprises experiencing cash flow difficulties to pay off their loans ahead of time for fear of overdue payment. The monthly interest rate of non-governmental loans is generally over 1%, plus an asset appraisals fee, financial fee, and guarantee fee. The annual interest rate of non-governmental loans will generally fall between 20–30%. In general, financing costs have increased by 40–50%.

The rise of raw material prices as a result of the crisis has contributed to the increasing costs for enterprises. Since 2007, the prices of large volumes of goods such as energy have fluctuated greatly, increasing pressure on input costs. The price of raw materials went up by 11–15%, while the factory price of the enterprise only increased by around 5%.

After the Labor Contract Law was implemented, the labor cost for enterprises went up dramatically. For instance, the labor cost of labor-intensive enterprises in Jiangsu Province increased by 20–30% on average.

The dramatic rise of comprehensive corporate costs seriously narrowed the room for profit for enterprises, and many enterprises incurred just slender profits or even operating losses. The labor-intensive industry was impacted to a conspicuous extent.

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