VZCZCXRO8125
PP RUEHCN RUEHGH RUEHVC
DE RUEHBJ #2952/01 2951033
ZNR UUUUU ZZH
P 221033Z OCT 09
FM AMEMBASSY BEIJING
TO RUEHC/SECSTATE WASHDC PRIORITY 6575
INFO RUEHOO/CHINA POSTS COLLECTIVE
RUCPDOC/DEPT OF COMMERCE WASHDC
RUEATRS/DEPT OF TREASURY WASHINGTON DC

UNCLAS SECTION 01 OF 03 BEIJING 002952 
 
SIPDIS 
 
SENSITIVE 
 
TREASURY FOR OIA CWINSHIP AND TTYANG 
 
E.O. 12958: N/A 
TAGS: ECON EIND EFIN CH
SUBJECT: CHINA/SMEs/REBALANCING: TRYING TO OVERCOME ANTI-SME BIASES 
 
Refs: A. Priscilla Hoffman-Stowe/Laura Stone email, October 9, 2009; 
¶B. FBIS/OSC #CPP20090924308001; C. 08 Shanghai 550 
 
¶1. (SBU) SUMMARY:  China's largest, often State-owned companies have 
benefited handsomely in recent years from overt government 
favoritism aimed at quickly stimulating the economy, and in the 
longer term at building strong national champions.  Smaller firms 
have also had to contend with a poorly developed financial sector, 
barriers to entry in many sectors, an inadequately-trained 
workforce, and ineffectual legal protections.  The result has been 
stunted growth of smaller, innovative and service-oriented 
companies.  To combat this trend, recent high profile policy 
statements indicate the leadership seeks to re-focus attention on 
advancing a more robust private sector.  However, the structural 
bias toward powerful State-owned enterprise (SOEs) will be hard to 
reverse.  Despite new policies aimed at re-orienting growth, China's 
small- and medium-sized enterprises (SMEs) continue to struggle. 
(Note: This cable provides information in response to Ref A. End 
note.)   END SUMMARY. 
 
------------------------ 
SMEs a Growth Engine, But Face Obstacles 
------------------------ 
 
¶2. (SBU) Chinese data on SMEs are notoriously problematic since many 
small service providers are unregistered, but according to official 
statistics China has at least 10 million SMEs that make up 60 
percent of China's GDP, and account for 99 percent of total 
enterprises and 80 percent of urban employment.    These smaller 
firms and businesses, according to Dragonomics Economist Arthur 
Kroeber, have created almost all Chinese job growth in the last 
decade and have contributed disproportionately to GDP growth.  A 
Deloitte report called SMEs "powerful transformational agents" and 
"innovation centers," key to China's rise as a global competitive 
force.  Nevertheless, SMEs have been heavily impacted by the 
financial crisis, highlighting their role as employers and 
exporters.  Jie Yao, Professor at the School of Economy and 
Management in Northeast Dianli University, told Econoff that 
export-based SMEs face considerable obstacles and were adversely 
impacted by the economic crisis: "Many Chinese export-oriented SMEs 
closed down because of their weak vitality and weak competitive 
strength."  According to the Ministry of Finance, 40 percent of 
China's SMEs stopped production and/or apply for bankruptcy as a 
result of the economic crisis. 
 
¶3. (SBU) Despite SMEs' major contributions to economic growth and 
employment, they are virtually barred from participating officially 
in some of China's fastest-growing sectors, which are often 
monopolies dominated by the state sector.  In telecoms and Internet 
Services, for example, SMEs have limited access, although they could 
in theory obtain licenses as service providers.  In the past, the 
coal industry was open to SMEs, but the Chinese government is now 
enforcing large-scale consolidation and closing small mines in order 
to reduce the number of mining fatalities.  Infrastructure projects 
go to large, typically state-owned firms, but SMEs can often get 
part of the pie as subcontractors.  Even where there are no formal 
barriers, however, SMEs usually lack the political ties needed to 
overcome opaque regulatory regimes, corruption and weak rule of law, 
poor IPR protection, and a government procurement system that 
rewards the companies that have political connections and resources 
to lobby for contracts. 
 
---------- 
Lack of Credit 
---------- 
 
¶4. (SBU) SMEs also lack basic access to credit (See Refs B and C). 
In a press conference earlier this year, Minister of the Ministry of 
Industry and Information Technology (MIIT) Li Yizhong identified 
availability of capital as the single most important culprit for 
SMEs' difficulties.  Zhang Qizuo of China International Economic 
Research Group pointed to lack of capital as a major problem: "The 
financing problems of SMEs have not yet been properly resolved." 
Under recent government initiatives, loans to SMEs reached 54 
percent of total outstanding corporate loans at the end of June 
2009, and grew at a faster rate than overall corporate loans.  While 
this is an improvement over previously woeful credit access, it 
still represents tight credit conditions and allows little slack for 
start up businesses. 
 
¶5. (SBU) SMEs' difficulties accessing capital stem from the lack of 
a credit information system and the ability to charge interest rates 
appropriate for the level of risk, in combination with the central 
government's continued reliance on lending quotas rather than more 
normal monetary tools to control excess liquidity in the economy.  A 
Jiangxi Chamber of Commerce official recently told Econoff that SMEs 
rely heavily on China's large financial institutions, but banks 
 
BEIJING 00002952  002 OF 003 
 
 
under-serve local SMEs because the banks lack sufficient familiarity 
and credit information on SME firms.  As a result, according to the 
official, under-ground financing is prevalent and plays a key role 
fulfilling the un-met demand for loans.  Underground financing 
includes county governments and local businesses making informal 
financing arrangements to fill the gap, as well as informal business 
and illegal operations.  He explained that information about credit 
worthiness is often limited by region.  For example, when a company 
wants to expand or borrow money from financial institutions based 
elsewhere, it encounters difficulty, particularly outside of large 
cities. 
 
¶6. (SBU) Rural Credit Cooperative (RCC) branches have had some 
success where lending by large state-owned banks have fallen short. 
According to the official, RCC's extensive rural branch networks 
gave them knowledge about SME credit worthiness that other financial 
institutions lack.  However, there are indications that even credit 
from the RCCs is drying up.  Caijing magazine recently reported that 
the RCCs have unduly favored local infrastructure and real estate 
projects at the expense of lending to smaller borrowers.  China has 
growing private equity and venture capital industries, but private 
equity firms focus on large firms ready to make initial public 
offerings, and the lack of credit information prevents funding from 
these channels from reaching many Chinese SMEs. 
 
-------------- 
The Dearth of Talent 
-------------- 
 
¶7. (SBU) In addition to the short-term access to credit challenges 
facing SMEs, the longer-term challenge of attracting, developing, 
and retaining talent serves to shackle private sector growth.  SMEs 
have historically lost talent to well-known multinational brands, 
famous SOEs, and stable government packages because, according to 
Jim Quigley and Chris Lu of Deloitte, SMEs are "weakly branded, 
patriarchal, and family dominated."  Beyond losing the battle to tap 
into the available talent market, SMEs further lose in their ability 
to develop and add value to existing employees. 
 
------------------------------ 
But the Government Has A Plan! 
------------------------------ 
 
¶8. (SBU) As China moves to promote more sustainable balanced growth, 
it has given new attention to growing the economy's service sector 
and promoting SME growth.  In late September 2009, the China State 
Council issued "Certain Opinions of the State Council on Further 
Efforts to Promote the Development of Small and Medium-sized 
Enterprises" (see Ref B).  This document outlines a range of pro-SME 
programs, including the development of a special credit fund, 
improving science and technology innovation policies, preferential 
tax policies, lowering market access thresholds in traditional 
service monopolies as well as other areas dominated by large-scale 
enterprises, giving SMEs preferences in government procurement, 
encouraging SME lending, allowing a new NASDAQ-type market, and 
reducing business registration and transaction fees. 
 
¶9. (SBU) Some programs to stimulate SMEs are already in place, and 
the State Council Opinion merely summarized ongoing efforts.  For 
example, measures were announced in August 2009 to help SME 
exporters through export tax refunds and export credit insurance; 
the China Association of Small and Medium Enterprises has set up a 
venture investment fund; and a corporate bond to raise funds for a 
group of SMEs Liaoning Province was issued in May 2009.  Moreover, 
commercial banks such as the Bank of China, China Commercial Bank, 
and Minsheng Bank set up separate SME business departments to 
support SMEs, and an SME board was recently established on the 
Shenzhen Stock Exchange.  Also, funds available for lending from 
MIIT's development fund for small and medium-sized enterprises 
increased from RMB 3.9 billion (571 million USD) in 2008 to RMB 9.6 
billion (1.4 billion USD) in 2009.  MIIT also is working to increase 
technical, management, and business training for SMEs.  Before the 
State Council Opinion was issued, according to a RCC official in 
Jiangxi Province, the provincial government directed that one third 
of new lending go to SMEs.  In the past, RCCs waited for SME 
borrowers to come to them, but now RCCs aggressively target SME 
customers. 
 
------------------ 
Comment: An Uphill Struggle 
------------------ 
 
¶10. (SBU) Beijing has had a stated goal of spurring SME development 
for at least eight years, thus far to little effect.  Because of the 
scale and structural nature of the biases against SMEs, getting 
funding to flow towards smaller firms without implicit government 
guarantees will be difficult without wholesale reform of the Chinese 
 
BEIJING 00002952  003 OF 003 
 
 
economy.  The State Council's SME Opinion appears to reflect the 
government is taking the health of SMEs seriously; it also calls for 
providing real financial and technical support to ongoing 
initiatives.  However, the document does not include details, which 
are expected to be fleshed out in subsequent policies and 
regulations.  Even in the face of a newfound policy to promote SME 
growth and development, challenges remain colossal and include weak 
financial infrastructure in the provinces, lack of transparency and 
variability in local rule of law, as well as local government 
corruption and favoritism.  Until China achieves real financial 
reform in the form of risk-based interest rates for business loans 
and control over petty corruption, plans to support SMEs will have 
trouble gaining purchase.  The largest short-term barrier remains a 
lack of access to capital from the formal financial sector, which 
forces SMEs to maintain high savings and hinders business 
re-investment.  In the long-term, talent recruitment, development 
and retention will be crucial.  Overcoming these challenges will 
likely limit the reach of China's rebalancing efforts in the 
foreseeable future. 
 
HUNTSMAN