Finance may upset China's reform efforts

Chinese Premier Li Keqiang has quite a long reform agenda, and allowing easier credit for small business is one of the toughest items on the to-do list.

In the State Council's executive meeting on Wednesday, Premier Li again pledged to reduce financing costs for enterprises, particularly for small businesses.

Since May 2013, the premier has discussed finance reforms at least 18 times in similar meetings, vowing repeatedly to channel more credit to small business, as financing has been a major obstacle to business growth in China.

For small business, difficult access to credit and high financing costs are a "structural problem," according to a statement by the State Council after the meeting. Ten measures, including an optimized credit structure, removal of unnecessary charges, and more small and medium-sized banks, were adopted at the meeting to support the real economy.

"Although the macro data suggest the economy has stabilized in the first half, the micro side of the economy is far from optimistic," said Wang Jun, a researcher at the China Center for International Economic Exchange.

"The difficulties are there, and the growth momentum is weak," Wang said, noting the real economy has been weighed down by wholesale price declines for 28 consecutive months and soaring financing costs.

China's credit binge in recent years came with huge and unmet demands from more desperate and less financially capable small companies, which typically lost in the race for loans against much stronger and larger state-owned enterprises (SOEs).

China's M2, a measure of cash in circulation and all deposits, totaled nearly 121 trillion yuan (19.5 trillion U.S. dollars) by the end of June, 1.5 times the amount in the United States and about twice the size of the entire Chinese economy.

The tidal wave of M2 growth mainly reached the gigantic SOEs and large companies, leaving small businesses desperate for loans.

However, small and medium-sized companies create more jobs for the country than SOEs.

Since 2009, private enterprises have on average paid interest 225 basis points higher than their state-owned peers, the All-China Federation of Industry & Commerce has found.

The structural problem could cripple China's efforts to rebalance its economy through freeing up small business and reforming its state-owned sector, analysts said.

To support the real economy, financing costs must fall and banks must streamline their intermediary process in granting loans, according to Guo Tianyong, a researcher at the Central University of Finance and Economics.

"After taking in deposits, banks should directly lend to needy enterprises without too many twists and turns in the intermediary process," Gao said, adding that the rush by lenders to sell wealth management products in recent years rather than granting normal loans is unhealthy.

Chinese companies' reliance on bank loans for growth rather than on raising money directly through stocks or bond issues could also send China into a lasting zero-sum conundrum between state firms and small business.

Lian Ping, chief economist at Bank of Communications, said simply pressing big banks to serve small companies won't work because big lenders have their own business model.

"The real solution to the problem lies in the vast development of small and medium banks targeting small businesses," Lian said, urging the state to hasten the approval process for more small and medium private banks.

To bring down financing costs, the country needs to look far beyond commercial banks, Wang said, pointing out that the costs to raise money directly through stocks and bond issues are lower.

"We need to enter these markets now and fast," Wang said.