China’s Repressed SMEs

BEIJING – Financial repression – government policies that create an environment of low or negative real interest rates, with the goal of generating cheap financing for public spending – has long been a key feature of Chinese economic policy. But, with funding costs for businesses trending up, this is finally starting to change.

Early this year, the State Council, China’s cabinet, made lowering funding costs for businesses, especially small and medium-size enterprises (SMEs), a top priority. For its part, the People’s Bank of China (PBOC) has engaged in cautious monetary loosening, which includes freeing up more funds for lending by banks that allocate a certain proportion of their total loan portfolio to SMEs. The PBOC, through its “pledged supplementary lending” program, has also started lending directly to banks that have promised to use the funds for social housing construction.

But, so far, efforts to lower funding costs have had a limited impact. Indeed, the weighted average interest rate on bank credit to nonfinancial enterprises remains close to 7%, while economic growth has edged down from 7.4% year on year in the last three months to 7.3% in the current quarter.

The situation may not be dire yet, but it is far from ideal – especially at a time when the Chinese authorities are pursuing structural reform. The PBOC now faces a dilemma. If it loosens monetary policy further – by, say, cutting banks’ reserve requirement ratio – the momentum for restructuring could be lost; and there is no guarantee that the additional liquidity would flow into the real sector. But if the PBOC refuses to budge, the combination of high interest rates and slow growth may send the economy into a tailspin.