The Rise of SMEs in China

The Rise of SMEs in China

24. November 2021
Small and medium enterprises (SMEs) are the driving force of China’s economic growth. Since the economic opening of China in the 1980s and the possibility for private enterprises to enter the market, they have continued to thrive, currently making up about 97% of all enterprises in China.

 

The Chinese market is also becoming increasingly attractive for foreign SMEs, with a variety of glistering opportunities among the changing circumstances and challenges. The key factor to a successful entry into the Chinese market is to be well informed – future investors, take out your notes: follow us into a quick introduction to the definition, current situation, challenges, and opportunities for SMEs in China.

 

How to define SMEs?

 

Compared to other OECD economies, the definition of SMEs in China is a little more complex. Instead of only looking at the number of employees, SMEs are defined based on China’s SME Promotion Law from 2003. The classification differs between industry categories and is based on the number of employees, sales, and assets. A first glance at the following chart of the exact classifications might be surprising – their size seems to be quite big compared to European or U.S. SMEs. Yet if we consider the labor intensity of the production and the huge size of China, they are in fact relatively small.

 

Size Category Industries Employment-based Total assets Business revenue  
 
Small Industry < 300 < 40 mil. RMB < 30 mil. RMB  
  Construction < 600 < 40 mil. RMB < 30 mil. RMB  
  Wholesale < 100   < 30 mil. RMB  
  Retail < 100   < 10 mil. RMB  
  Transport < 500   < 30 mil. RMB  
  Post < 400   < 30 mil. RMB  
  Hotel Restaurant < 400   < 30 mil. RMB  
Medium Industry 300 – 2000 40 – 400 mil. RMB 30 – 300 mil. RMB  
  Construction 600 – 3000 40 – 400 mil. RMB 30 – 300 mil. RMB  
  Wholesale 100 – 200   30 – 300 mil. RMB  
  Retail 100 – 500   10 – 150 mil. RMB  
  Transport 500 – 3000   30 – 300 mil. RMB  
  Post 400 – 1000   30 – 300 mil. RMB  
  Hotel Restaurant 400 – 800   30 – 300 mil. RMB  
Note: SMEs meet one or more of the conditions. MEs should meet three conditions, the others are SEs.   Source: SME Promotion Law of China, 2003.

 

 The backbone of China’s economy

 

A lot of changes happened since China’s economic structure has been transformed in its fundaments. From 1998 to 2003, nearly 19 million workers left state-owned enterprises (SOEs) to get reemployed at SMEs. The number of SMEs in China is growing rapidly: in the 1990s, more than one million private SMEs emerged – 10 years later their number skyrocketed and overthrew those of Europe and the U.S. combined. In 2004, the number of SMEs in China rose to over 40 million according to China’s National Bureau of Statistics (NBS). Let’s put that into perspective: the number of SMEs in Europe at that time was about 10 million.

 

According to the China Statistical Yearbook, in 2015 SMEs made up about 97.9% of all registered companies in China. Their total assets have been around 53.4% of Chinas total number, their revenue was 62% of the total and the profits were 64.3% of the total with a number of 4.26 billion Yuan. They also contributed nearly 58% of the GDP and 68% of exports. SMEs also provide most of the total employment opportunities: 82% of employees find their workplace at an SME.

 

Despite the slowing growth of the Chinese economy, SMEs are still on the rise. In 2016, net profiles of SMEs listed in the National Equities Exchange and Quotations system (NEEQ) rose about 26.29% and their annual reports showed an increase over 25% of the annual business revenue. The total assets also expanded about 23.9%. Expenses for research and development also increased to a total number of 11.58 billion RMB.

 

  Financing issues 

 

Let’s have a look at the hurdles that SMEs are facing in China. The SME’s worst adversary is a troublesome access to funding. While the SOEs and big companies get their loans from state institutions, SMEs are mostly left out in the cold. Here are some facts to create a picture of the situation: According to China’s Enterprise Surveys data,

 

 
  • more than 40% of the surveyed enterprises had troubles with underfunding
  • about 66% of recent SMEs had problems to access bank financing
  • in 2013 only 23.2% of bank loans were given to SMEs
  • only 4.7% of SMEs short-term capital loans were extended

 

  What are the reasons for the puzzling lack of financing options, given the important role that SMEs play for the Chinese economy? If we look at a survey of the HKUST IEMS in 2015, we see that the bank system privileges SOEs rather then the private sector in lending loans. This can be explained by two main factors.

 

First, there is the problem of information asymmetries that SMEs face within the credit market. Especially enterprises in the early stages of development might be short of formal corporate structures and fixed assets as collateral, plus ownership and financial structures could appear as non-transparent. In a nutshell: lenders often have a lack of full information about the borrowers. This can lead to insufficient credit availability and incorrect loan application evaluations.

 

Secondly, there are some obstacles lurking within the structure of China’s financial system: the high market share of state-owned commercial banks, interest rate controls, the insufficient development of the capital market, and restrictions on cross-border capital transaction all lead to a lack of financing for SMEs. Because the government-owned financial institutions are designed to facilitate national economic development, only small parts of the loans can be contributed to SMEs. There are also important ideological and political influences to consider: using party-state resources to support capitalist ventures might be regarded as contradictory.

 

  So, how do I finance an SME in China?

 

Despite the obstacles, there are some options on the plate. With the absence of sufficient funding options from government-owned banks, most SMEs finance their business with non-banking sources. In the mid-1990s and 2000s, two thirds of all SMEs relied on informal finance. In China, informal finance is a “quasi-regulated” sector. There are financial institutions that are not supervised by the Central Banking Regulatory Commission (CBRC). These finance institutes are registered as local branches of other bureaucracies. The main difference between banks and non-banking-financial-institutions (NBFI) is, that the NBFI are not permitted to accept deposits. According to the CBRC, only banking entities with financial licenses are permitted to mobilize deposits from the public. Financial institutions are not permitted to charge interest rates more than four times the benchmark lending rate set by the PBOC. In the following we have complied a list of the most common NBFIs.

 

Type of NBFI Registration Authority Registered (year)  
 
Credit guarantee companies Provincial governments: Public Finance Office 8,427 (2012)  
  SME Bureau, local Finance Department    
  County governments: CBRC NBFI division    
Microfinance/ small loan companies Civil Affairs Office: NGOs 8,217 (2014)  
  Local government: Finance Office    
Pawn shops ICMB, MOFCOM 7,000 (2014)  
Trust companies Provincial governments (< 64%) 68 (2014)  
  Central governments (15%)    
  Shanghai Trust Registration Center (not enforced)    
  CBRC    
Leasing companies CBRC: domestic; MOFCOM: JVs, WFOEs 26 (2014)  
Rural mutual aid funds ICMB, Poverty Alleviation Bureau    
P2P lending platforms ICMB 1,627 (2015)  
Crowd funding platforms ICMB 114 (2014)  
CBRC: China Banking Regulatory Commission, ICMB: Industrial & Commerce Management Bureau, MOFCOM: Ministry of Commerce, NBFI: Non-banking financial institution

 

  Top 3 SME Trends 

 

What does the future hold for SMEs in China? Although getting financial support from local banks can be tricky, setting up an SME provides a variety of opportunities to success. There are some key sectors that are in the spotlight. Here, we present the three most important trends according to an article by EURObiz:

 

 
  1. China’s industrial sector is focusing on climbing up the value chain and strengthening their manufacturing. Therefore, they are always looking for new opportunities to automatize and modify their supply chains to be more sufficient. The fields that provide a high chance for successful investment are industry robotics, machine tools, as well as transportation and agriculture equipment. Next to materials, there is an especially high demand for know-how on manufacturing technology.
 
  1. In China, domestic consumption is on the rise. With the growing middle class, European products enjoy an increasing demand – especially luxury products are en vogue among Chinese consumers. An important point for European companies to keep an eye on is to offer a variety of selling channels, including e-commerce.
 
  1. There is an expanding interest for outbound investment. Year by Year, more Chinese investors try to invest in other countries and economies. This creates an attractive opportunity for SMEs to address the demand for services such as specialist management consulting and financial services, or to provide private equity to venture companies and to build future-oriented business relations.

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