Chinese Economy Already Cooling... Will Debt Bomb Explode for Chinese SMEs?

Increase in Delinquency and Default of SME Loans in China

In China, the number of small and medium-sized enterprises (SMEs) unable to repay their loans is increasing. As the economic recovery falls far short of expectations, companies that had been eagerly awaiting the lifting of COVID-19 lockdowns now face concerns about survival. With the loan volume surging since the pandemic, there are growing fears of large-scale defaults.

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On the 18th (local time), the Wall Street Journal (WSJ) reported that the delinquency and default rates of loans to Chinese SMEs are soaring sharply.

According to Lufax, China's largest online peer-to-peer (P2P) lending platform, the loan delinquency rate (the proportion of loans overdue by more than 30 days) was 6.4% at the end of March this year. This bank mainly provides loans to SMEs, and the delinquency rate has more than doubled from 3% a year ago. The default rate, which refers to loans overdue by more than 90 days, surged from 1.6% to 3.7% during the same period. MyBank, a Chinese internet bank primarily serving small business owners, also saw loans overdue by more than 30 days double compared to a year ago as of the end of last year.

The worsening financial difficulties of SMEs are a result of China's economy failing to quickly rebound despite the reopening of economic activities at the end of last year. A recent survey by the China Association of Small and Medium Enterprises of 3,000 companies found that only 40% of firms operated their factories at full capacity. The business sentiment among companies is also bleak. China's Small Business Purchasing Managers' Index (PMI), a leading economic indicator, stood at 47.9 last month, marking two consecutive months below 50 (indicating economic contraction).

Other economic indicators are also weak. China's exports in May fell 7.5% year-on-year, missing market expectations (-0.4%). Retail sales and industrial production in the same month slowed to 12.7% and 3.5%, respectively, both below the previous month and underperforming forecasts (13.6% and 3.6%). The Chinese government is considering large-scale stimulus measures to boost the real estate and domestic economy for these reasons.

Amid this situation, loan maturities for SMEs are approaching. According to the People's Bank of China and regulatory authorities, SMEs must repay loans maturing in the fourth quarter of last year by the end of this month. With the economy struggling to recover, there are concerns that more small businesses will be unable to repay their loans as these maturities come due.

The significant increase in SME loan balances since COVID-19 also poses a risk of larger default volumes. Chinese authorities have emphasized smooth financing for companies after the pandemic and pressured banks to extend SME loan maturities. As a result, SME loan balances surged from 38.9 trillion yuan in Q1 2020, when COVID-19 emerged, to 64.5 trillion yuan in Q1 this year.

Jay Guo, a former banker and director of the Ningbo China Research Institute, stated, "Chinese banks have allowed some SMEs to extend their loans, but if these companies fail to repay in the future, defaults are inevitable. It is reasonable to extend loans only when the economy rebounds and SMEs can sell their products."