a Way out for Private enterprises

By HE LIU

CHINAs private enterprises

quickly became the major driving force of the nations economic growth when China first introduced its reform and opening-up policy in late 1978, and they have continued to play a massive part in its development for more than three decades. Since then, private enterprises have contributed to more than 50 percent of Chinas GDP growth and over 70 percent of new jobs.

Many private enterprises today, especially small and medium-sized enterprises (SMEs), however, are finding it difficult to stay profitable. They face problems including heavy taxes and difficulties obtaining finance. Their plight has caused concerns in the government, which is aware of their importance for Chinas economic health.

eliminating Discrimination

Last year, Chinas export enterprises suffered a sharp decrease in orders due to the escalating European debt crisis, and export growth fell for five consecutive months from August to December. There is little hope for immediate recovery and forecasts for 2012 are gloomy, predicting both export and import growth would slow down even further.

Conditions in China are making it difficult for private enterprises to keep their head above water. Li Zhongjian, president of Wenzhou Tung Fong Light Industrial, gave up a number of large orders in 2011, anxious about changes in the exchange rate and working capital turnover. His company, like many other private enterprises, is struggling to survive in the shadow of slowing GDP growth, cautious monetary policy, fluc- tuations in the exchange rate, rising costs of labor and raw materials and frequent trade disputes.

According to Bao Yujun, president of the All-China Private Enterprises Federation, only 29 percent of private enterprises are now able to make substantial profits in the economys current state. Most of these are former state-owned enterprises, while others are well funded, with at least RMB 50 million of registered capital, enjoy monopolies or are involved in new industries.

“Though some private companies do not need to worry about their future, most are faced with difficulties,” Bao Yujun said. This opinion is shared by Cai Hongping, Asia Investment Banking chairman at Deutsche Bank. Cai holds that China has witnessed the peak of its industrialization and is transforming

from a shortage economy to a surplus economy. “Private enterprises used to be able to make profits as long as they produced goods in short supply,” Cai explained. Now, to survive the increasingly intense competition since Chinas accession to the WTO, companies have to bring in industrial upgrading. “This is a defining moment for the private sector.”

Change, including industrial upgrading, is never easy. Most SMEs are low in the industrial chain, limited by capital, technology, management and human resources. On top of this, the macroeconomic controlsintroduced to deal with the 2008 economiccrisis have worsened conditions for them, and their already meager profits plummet when they encounter a rise in costs and fluctuations in the exchange rate.

The private sector also faces barriers in industries monopolized by stateowned companies. On May 13, 2010, the State Council issued “Several Opinions on Encouraging and Guiding the Healthy Development of Private Investment,” but no implementary regulations have been promulgated. Industries like telecommunications, finance and electricity are still solely in the hands of state-owned enterprises.

A survey by the All-China Federation of Industry and Commerce has revealed that after the economic crisis of 2008, some private companies abandoned their major businesses that had slim profit margins and blindly invested in high-tech and speculative industries. An extreme example of this is Hu Fulin, founder of Zhejiang Center Group, one of Chinas biggest manufacturers of glasses. Hu put most of his capital into a photovoltaics project, which disrupted the flow of funds to other areas of the company. After running up debts of RMB 2 billion, Hu fled to the United States.

Despite these dreary tales, there are those who are positive about the future.“Though some say private companies will shrink, I am optimistic because Chinas economy cannot develop without a private sector,” Bao Yujun said.

Wang Tao, chief economist of China Economic Research for the United Bank of Switzerland, is of the same mind. She holds that though the government is capable of keeping economic growth at around eight percent in the short term with the current economic makeup, the nations long-term development lies in the hands of an active private sector. As such, the relaxation of restrictions on private companies entering finance, health care and the service industry will result in healthier development.

Reducing tax Burdens

Of the top 100 private enterprises in Wenzhou in 2010, most were involved in more than one major business and over half had invested in real estate and finance. Cai Hongping found that many of the heads of these companies had also begun to speculate in the stock market and trade of natural resources. To him, this is a disaster, as capital flowing out of the real economy will result in a hollow economy as a whole. Zhou Xiaochuan, governor of the Peoples Bank of China, has vowed on several occasions that the financial market will step in and better serve the real economy.

Ma Yu, a senior researcher at the Ministry of Commerce, has made a number of trips to Zhejiang to investigate the situation experienced by local private company owners. He found that private companies began to move away from the real economy two or three years ago. “The bosses complain that running a company is extremely hard and tiring. Whats more, they are not able to avoid nonmarket risks. Some lose what they spent decades earning overnight.”

Ma concluded tax burden is among the three main plights that private companies are facing, the other two being financing problems and unpredictable risks. SMEs bear heavier taxes and dues than big businesses. On top of this, SMEs also have to fork out 69 items of administrative fees charged by over a dozen of departments. Small and mediumsized manufacturing businesses managed to keep their annual profit at eight to ten percent when economic turmoil first hit in 2008, but by 2011 that figure had dropped to between one and three percent. With such slim profits, Zhou Tianyong, deputy director of the Institute for International Strategic Studies at the Party School of the Central Committee of CPC, argued that under the current taxation system, 90 percent of private SMEs will go bankrupt unless they dodge taxes.

In October 2011, the State Council launched a series of measures to support the development of small and micro businesses, including raising the thresholds for value-added tax and business tax for businesses below a certain size, extending the half income tax policy for small businesses to the end of 2015 and expanding its scope, and exempting small businesses from stamp duty on bank lending contracts for the next three years. This was followed by a series of supporting regulations from the Ministry of Finance.

Many small and micro businesses are on the verge of making a loss, so they have benefited little from the half income tax policy. What they badly need is the reduction of value-added tax and business tax. Ma Yu believes that the policy is woefully inadequate and will do little to help the private firms that are beset with internal and external troubles.

Earlier this year, Shanghai began to pilot a project that replaced business tax with VAT in the transport sector and some areas of the service sector. According to Jia Kang, director of the Research Institute for Fiscal Science under the Ministry of Finance, this has avoided double taxation and helped alleviate the tax burden on SMEs.

solving the Financing Problem

Ma Weihua, president of China Merchants Bank, was deeply impressed with one concept that he heard during G20 Summit in 2010:“If there is one thing that will solve the problems of unemployment and poverty and lead the world out of the shadow of financial crisis, it is the success of SMEs.” The financing of SMEs is a problem around the world.

In order to stimulate the economy during its slowdown in 2008 and 2009, China invested RMB four trillion, mainly in large state-owned enterprises, infrastructure and real estate. Small and medium-sized private firms didnt get a share of this stimulus package. When China adopted a more prudent monetary policy in 2010, SMEs were the first to feel the effects.

According to Liu Wei, vice president of Peking University, the marketization of production factors is the key to solving SMEs financing problem. China has in essence achieved its goal of commodity marketization after 30 years of reforms. Now, it is doing the same for the interest rate and production factors such as capital, land and patents and creating a more open and equal trade environment. Only in this way can we deal with such problems as unfair competition and low efficiency.

It is hard for small and micro laborintensive enterprises to obtain loans from banks. No large enterprises and SOEs get turned down for finance from banks, and 20 percent of medium-sized enterprises can get loans from banks. This is most damaging to those SMEs that are not able to upgrade their production techniques and compete with other producers on the market due to insufficient funds and have to rely on private lending.

Data from the All-China Federation of Industry and Commerce indicate that 90 percent of small firms cannot obtain loans from banks while 95 percent of micro enterprises have never acquired a bank loan. In June 2011, China Banking Regulatory Commission released the Notice on Supporting Commercial Banks in Further Improving Financial Services for Small Enterprises. Senior economist Zhou Dewen, however, considers this notice merely as instructions on principles. Banks still close their doors to SMEs and at present there are few small-loan companies.

It is natural for commercial banks to protect their own interests by lending to SOEs, since SOEs are government guaranteed. Although the interest rate for loans to SMEs is generally 20 to 30 percent higher than that paid by large state-owned companies, commercial banks have little interest in lending to SMEs due to a lack of a pricing system that reflects risk.

According to Ma Yu, if state-owned banks are unwilling to lend, then the market should be opened to private finance. Statistics from Wenzhou Branch of the Peoples Bank of China show that 89 percent of families or individuals and 59.67 percent of enterprises in Wenzhou have engaged in private lending, creating a cash market worth RMB 110 billion in total.

The private lending crisis that Ma Yu has witnessed in Zhejiang Province is undoubtedly a motivation for the government to standardize private lending. On March 28, the State Council decided to make the city of Wenzhou a pilot region for comprehensive financial reform. Among the 12 tasks put forward in the plan, the first is to “standardize and develop private financing,” indicating that the central government officially recognizes private finance, which has up to now been somewhat of a gray area.

The second task put forward in the pilot plan is to allow private capital to participate in the reform of local financial institutions, launching or holding shares in new types of financial organizations including rural banks, finance companies, and rural fund cooperatives that are in accordance with the law. The plan will also allow qualified microfinance companies to be restructured into rural banks. This indicates that policymakers not only recognize private finance as a valid form of lending, but also permit private lenders to operate as legitimate financial institutions.

According to Fan Jianjun, researcher at the Financial Research Institute, Development Research Center of the State Council, rural banks and community banks are a good fit with local SMEs and have advantages in risk management. The government also vowed to encourage the establishment of financial leasing enterprises that serve small and micro enterprises as well as sectors concerning farmers, agriculture and rural areas.

Financing SMEs is complicated and there are many details that must be considered when introducing reforms, and measures are still needed to be introduced by the relevant regulatory departments. The government, however, is moving in the right direction and exploring options to solve the financing problems of private enterprises.