Talk is cheap but Xi will need to walk the walk
Jeremy Stevens
Xi, and key economic policymakers, have now spent weeks stressing that China will continue to encourage, support the development of the non-public sector, and promising “competitive neutrality” – essentially a level playing field between private and state actors.
In the past few months, each of the key state apparatus has held multiple meetings and issued papers stating frank support for the private sector. Xi even wrote to private firms last month, and he visited the entrepreneurial heartland in the south to discuss the role of SMEs in the China’s socialist market economy.
Admittedly, private firms have borne the brunt of supply-side structural reform, shouldered the burden of financial de-risking and deleveraging efforts, and are exposed disproportionately to the trade war with the US. Undoubtedly, private enterprises’ investment in manufacturing has been critical in offsetting weak infrastructure and real estate investment this year.
Even though fixed asset investment has managed just 5.8% YTD through to September – the lowest ever pace of increase – private sector investment has proven surprisingly robust. Investment by SOEs has been contracting but private firms have accelerated their investment in 2018, increasing by 15.2% YTD (11.2% in 2017). Indeed, China’s investment in manufacturing, since hitting a cyclical bottom, has increased gradually – from 3.8% y/y in March 2018 to 8.7% y/y in September 2018.
The upshot is that, should the private sector falter, given the questionable ability and perhaps willingness of Beijing to stimulate via infrastructure investment, economic activity will falter more precipitously than expected.
With private firms exposed to trade war headwinds, numerous metrics clearly look worrisome. Last month the growth of value added of industry slowed from 6.1% in August to 5.8% in September, the lowest since 2008, dragged down by manufacturing which expanded by its slowest rate on record. Looking ahead, the official Purchasing managers index (PMI) fell from 50.8 in August to 50.2 in September, a 27-month low, on slowing domestic and external demand. New export orders are now at a 35-month low. The Caixin PMI may have risen slightly, to 50.0 in August to 50.1 in September, but it remains on the edge of contraction.
Private firms have also taken the biggest knock from the deleveraging campaign. SMEs borrow more from the smaller banks; banks which have seen funding channels evaporate in the last 18 months. Already, private firms have defaulted on CNY65.9 billion yuan of bonds this year – four times more than in 2017. And with developers and industrial firms shouldering the bulk of the repayment obligations ahead, cash squeezed private sector faces increasing pressure. Consider that net corporate bond issuance has increased by CNY1.58trn YTD, versus CNY174bn over the same period in 2017.
Late last month, the PBoC announced a USD22bn increase in financing as part of plans to support privately owned enterprises. Plus, the central bank plans to give CNY10 billion to a state-backed insurer to provide credit support for debt sales by private firm.
Recently, Xi announced several measures: tax relief; expanding financing channels; creating an equal business environment; improving policy implementation; building close relations between the government and businesses; protecting entrepreneurs' personal safety and properties.
At the very least, we expect forthcoming data to show that Chinese banks have started to increase lending to small businesses, but most of this will likely be used for working capital and not capex.
Besides the cyclical issues discussed above, long term obviously the smaller, privately owned firms will become even more critical to quality job creation. Since 2014, employment in the industrial sector has fallen from 100m to 88m due to capacity reductions connected with SSSR (and, to a lesser extent, industrial automation). In fact, employment growth in recent years is virtually entirely attributable to the expansion of employment in basic and advanced services, and those jobs have been created virtually just by SMEs.
Given the emphasis on quality of life, ensuring employment opportunities now for 6.5m university graduates annually (up from 5.8m five years ago) has become critical too. And, seemingly, this will fall to those SMEs operating in the new economy. Thus, keeping SMEs engaged and optimistic will be crucial, specifically as it pertains to government policy. This however will take more than just talk by Xi.
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