China Should Beware of Systematic “Weakening” in Its Private Economy

Shanghai city skyline
Credit: Sean Sheng / Pixabay

Since China’s reform and opening-up which took place over 40 years ago, its private economy has grown from scratch and has gradually become an important supporting factor in the country’s economic development. The term “56789” is commonly used in China to describe the private economy which contributes more than 50% of China’s tax revenue, more than 60% of GDP, more than 70% of technological innovation achievements, more than 80% of urban employment, and accounts for more than 90% of enterprises in China. In terms of actual contribution, the private economy has accounted a larger part. Chinese President Xi Jinping has also expressed the need for the private economy in China to be strengthened.

However, in recent years, the private economy has shown signs of continuous weakening. Data also shows that private capital investment has continued to shrink. Since 2012, the growth rate of private fixed asset investment has continued to decline. Private fixed investment in 2019 was RMB 3,115.9 billion, a year-on-year increase of only 4.7% (the national investment growth rate was 5.4% in the same period). From January to July 2020, fixed asset investment (excluding rural households) nationwide was RMB 32.9214 trillion, down 1.6% year-on-year. Of this, private investment in fixed assets was RMB 18.4186 trillion, down 5.7%.

The credit situation of private enterprises is continuously deteriorating. From 2017 to 2019, there were 1044, and 39 new bond defaulters in the bond market respectively, with 1038, and 32 private companies, respectively. In 2019, the default amount of bonds reached RMB 128.994 billion, and the default amount of private enterprises was RMB 100.205 billion, accounting for 77.68% of the total defaulted bonds. Private enterprises accounted for about 80% of the bond default scale with less than 9% of the stock of credit bonds. The private economy was hit the hardest in the bond market, and it is also deemed as vulnerable in the capital market; all of which reflects its overall poor operating conditions.

The poor financing environment of private enterprises is a persistent problem. At the end of 2018, the loan balance of private enterprises was RMB 32.8 trillion, accounting for 40.7% of the total corporate loan balance, which means that private enterprises used about 40% of bank loans to support the contribution of “56789”. The problems regarding the difficulties in financing as well as its high cost, have always been prominent in the private economy. Meanwhile, direct financing methods such as bonds, equity and venture capital are considerably weaker in the capital structure of private enterprises, as bank loans are still the main financing channel for private enterprises. Small, medium, and micro-sized private enterprises account for more than 95%-98% of the number of private enterprises. Since the management cost of loans to small and medium-sized enterprises, individual industrial and commercial households is about 5 times that of large and medium-sized enterprises, banks in China are less willing to lend to small and medium private enterprises. Due to a lower reputation, heavy financing burdens and insufficient asset mortgages, private enterprises generally cannot obtain enough funds from banks.

Surveys show that in terms of financing cost, the average financing cost of private enterprises is 8.2%, among which those with average financing cost above 10% account for 17.7%; while the average financing cost of state-owned and foreign-funded enterprises is below 7%. According to some local reports, under the situation of tight market liquidity, even some high-tech small and medium-sized enterprises with market, technological advantage and profitability lack collateral, and often encounter difficulty in obtaining loans directly from banks. They can only obtain loans through guarantees, with comprehensive financing cost above 10%. When some private enterprises take loans, the bank even requires the enterprise’s actual controller and spouse to sign and undertake unlimited joint and several liability.

In recent years, the profit rate of the private economy has continued to decline. From 2012 to 2019, the average annual growth rate of the total profit of private industrial enterprises above designated size was about 0.8%, which was far lower than the average annual profit growth rate of 51.3% in the previous decade. In addition, the leverage ratio of private enterprises continues to rise, business operations becoming more difficult, breaches of contract continue, and the number of corporate bankruptcies has increased as well.

Researchers at ANBOUND have observed a systematic “weakening” of China’s private economy, with private enterprises “aging,” “weakening,” “degrading,” and “passivating” in most industrial sectors, with the exception of a few areas such as internet technology, a sector that is actually pursued by capital. This year’s COVID-19 outbreak has posed severe challenges to private enterprises, including employment difficulties, severe shrinkage of orders, poor logistics, and broken capital chains. At present, China’s economic growth and risk prevention-control are under great pressure. In addition, the external environment of the private economy has not been optimistic for a long time.

In 2018, President Xi Jinping vividly summarized the main problems in the development of private enterprises into three major aspects at a private economy symposium; namely market, financing and transformation. Although China is aware of the problems encountered by the private economy in the context of the macroeconomic downturn and a series of other backgrounds, the system environment for the development of private enterprises still lacks substantial changes. Due to the increasing downward pressure on the overall economy, the problems of financing difficulties and expensive financing for private enterprises are even more difficult when compared to the past.

Considering the importance of the private economy to China’s development, China needs to re-emphasize the development of the private economy under the new historical background as an important part of reform and opening-up in this new era. China’s four decades of development shows that if there is no rapid development of the private economy, it will be difficult for the country to truly realize its “inner circulation.” It would also be difficult for China to effectively alleviate employment pressure from an active market economy and stimulate entrepreneurship to achieve real innovation. In short, it would mean that lacking all of these would inhibit Chinese companies from becoming truly competitive in the world. Looking back on the U.S.’ suppression of Chinese companies over the past two years, it is clear that the companies that truly made Americans feel the threat of competition are not the huge state-owned enterprises, but instead the private companies in China that have ideals, pursuits and who are bold enough to innovate.

The development of the private economy and the growth of private enterprises depend on various environments and factors. Some factors are external and beyond China’s control, but there are also some important factors which China can control and decide; these include policy and institutional environmental elements. It also means that China needs to further improve the political and legal status of the private economy and private enterprises. China should move towards not distinguishing the Chinese economy from Chinese enterprises by ownership, and towards a truly fair, rule of law and creditable market economy system.

The fundamental prerequisite for the decisive role of the market is to create an institutional environment for equal competition among various ownership economies. To improve the market economy system, it is necessary to realize the equality of the market status of various economic entities and the fairness of the competition process. To solve the plight of private economic development, private enterprises will have to make continuous progress. China also needs to further promote institutional reform and improve the institutional environment for the development of its market economy.

Mr. He Jun takes the roles as Partner, Director of China Macro-Economic Research Team and Senior Researcher at ANBOUND. His research field covers China’s macro-economy, energy industry and public policy.