China’s Small Businesses Are Hit Hard as Economic Recovery Falters
Beijing pushes banks to extend loans to small businesses, with limited success
5 min
China’s small businesses are cutting staff, struggling to pay off debt and nervous about the future. Their plight paints a grim picture of the country’s flagging recovery.
The country’s small and medium-size enterprises are crucial to the economy; they employed around 233 million people by the end of 2018, which was the last time this data was made public. But official data, recent disclosures from lenders and interviews with small-business owners show that many of these companies are suffering.
“The biggest problem for small and micro enterprises now is survival,” said Ji Shaofeng, the founder of a micro loan trade association based in China’s eastern Jiangsu province.
The struggles of China’s small businesses make clear how far the country has to go before it fully recovers from a series of lockdowns, which were part of Beijing’s strict response to the coronavirus.
When the government finally brought an end to its strict zero-Covid policy late last year, many economists expected a strong recovery. It hasn’t arrived. Consumer spending, factory orders and exports are among many indicators showing signs that the recovery is losing steam.
A recent survey of manufacturing purchasing managers in China showed a second consecutive month of contraction for small companies. China’s small-enterprise purchasing managers index is now at 47.9; a reading below 50 shows business activity is slowing.
Scott Yang, a wine and tea seller in Wenzhou, a city in China’s wealthy Zhejiang province, said many local business owners he knows are laying off employees and trying to cut costs, in response to a drop in factory orders.
Small enterprises started to add jobs at the end of the first quarter, when there was still some optimism about a recovery. But a PMI subindex showed employment at small enterprises was 48.7 in May, meaning these companies are either cutting staff or not replacing those who leave.
Huang Yiwen, who sells furniture online in Foshan, in southern China’s Guangdong province, said his business has been hurt by the weak property market, since new-home buyers are a reliable source of demand for furniture makers. Annual home sales fell to a six-year low in 2022, after a slump in the property sector that also led to debt defaults by some of China’s largest developers.
“It’s so hard to sell,” said Huang, regarding furniture.
Less than 40% of small and medium-size enterprises are operating at full capacity, which means producing all of the goods they can, according to the latest survey conducted by the China Association of Small and Medium Enterprises, which sends questionnaires to 3,000 SMEs in the country every month.
Economists warn that the problems facing small businesses can’t be isolated from the wider economy. Because small businesses are such a major source of employment, particularly in large cities, their struggles reflect—and could worsen—wider economic strains.
“If SMEs do not recover, it will be difficult for urban areas to create enough employment and income, which will have a significant impact on low- and middle-income families,” said Dan Wang, chief economist of Hang Seng Bank (China).
Chinese government officials are becoming uneasy about the economy and are planning a series of moves to stimulate growth, The Wall Street Journal recently reported. That could include billions of dollars of infrastructure spending and a loosening of rules in the property sector.
So far, Beijing’s attempts to prop up small businesses have focused mainly on making it easier for them to get funding. That has had limited success.
Since early 2020, Chinese regulators have pushed banks and other financial institutions to extend loans to small businesses that were hurt by the pandemic. In some parts of the country, local divisions of China’s central bank have sought to help small businesses by establishing teams to answer funding-related questions, as well as visiting factories and farms to assess their needs. The government has provided other targeted-relief measures such as tax exemptions and temporary rent reductions.
The total outstanding balance of loans to small and micro enterprises has been climbing, reaching the equivalent of $9 trillion at the end of March, according to data from China’s banking regulator.
Many small businesses in China don’t want to secure new financing unless it helps them clear previous debts. Yang, the wine seller, said that while financing is relatively cheap and easy to get, most local businesses he knows are borrowing only to stay afloat and not to expand.
Lufax, a Chinese internet-lending platform that caters mostly to small-business owners, said last month that about 5.7% of the total loans it facilitated were more than 30 days past due at the end of March. Its loan-delinquency rates, which are higher for unsecured loans, have risen for six consecutive quarters.
MYbank, an internet lender that serves small businesses, said in its latest annual report that the balance of its loans that were more than 30 days past due more than doubled last year. The company, an affiliate of the Chinese fintech giant Ant Group, said the impact of the pandemic and weak consumption last year caused many small- and micro-business owners to face continuous pressure.
Many commercial banks have given borrowers more time to repay their loans, extending their forbearance for small businesses to this year. Small businesses whose loans were due in the fourth quarter of 2022 will have until the end of this month to repay, according to a notice from the central bank and a group of regulators.
Chinese banks have allowed some small businesses to roll over their loans, but if these small businesses are unable to repay in the future, they will eventually have to be recognized as bad loans, said Jay Guo, a former banker and current dean at the Ningbo China Institute for Supply Chain Innovation.
“It only makes sense to extend loans if the economy rebounds and SMEs are able to sell their goods,” said Guo.
Ji, of the micro loan trade association, said that while some sectors such as tourism and catering have rebounded in the past few months, small businesses in manufacturing, trade and other industries are still under pressure as demand remains well below where it used to be.
Small businesses are falling victim to a vicious cycle that is affecting the wider economy, said Xiangrong Yu, chief China economist at Citigroup. The poor performance of some private companies is leading to a loss of confidence, and that low confidence is making it hard for those companies to do better, he said.
“Lack of confidence is both a symptom of the problem and the root cause of the problem,” said Yu.
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Strong family financial planning can help reduce taxes and support younger generations. From intrafamily loans and asset gifts to inheritance disclaimers, strategic cooperation can create meaningful financial benefits—when families have the trust and structure to make it work.
4 min
Happy is the family whose members—parents, grandparents and grown children—trust each other enough to cooperate on shared goals, especially financial ones. When that is truly the case, Uncle Sam’s tax rules can help as well.
This matters especially now that mortgage rates are above 7%, and many families are looking for ways to help younger members. If the elders have resources and are confident younger ones can cooperate, a family loan could make homeownership possible while providing the elders with a useful income stream.
Other strategies can actually lower taxes, such as when funding 529 plans or Roth IRAs, or when someone inherits a traditional IRA with required withdrawals larger than they will need.
Here are three strategies useful for functional families.
Intrafamily loans
It is perfectly legal for families to lend money to a relative for a down payment or even a private mortgage.
But it is important not to cut corners, says Ryan McKeown, a CPA with Modern Wealth Enhancement in Minnesota. If the loan is for a down payment, be honest with the mortgage provider and have a formal agreement. The lender owes tax on the interest payments received.
If the loan is for a private mortgage, both sides should have legal representation with a formal written agreement, including payment terms. The lender owes tax on the interest, and the borrower often can deduct it if he or she itemizes.
To avoid IRS trouble, the interest rate shouldn’t be lower than the agency’s Applicable Federal Rate at the time of the loan. Currently that is about 5% for loans longer than nine years; about 4.5% for loans three to nine years; and about 4% for loans three years or less. Currently, traditional mortgage rates are generally above 7%.
In addition, the lender could use the $19,000 annual gift-tax exemption (described below) to forgive some or all of the interest or principal annually. If both lenders and borrowers are married, that is up to $76,000 a year. There is no tax for the borrower on such forgiveness, because it is from a gift.
If you’re going this route, McKeown advises against having a fixed plan to forgive the debt. Instead, do it in one-off letters specifying the amount—and keep careful records. Otherwise the IRS might try to treat the loan as a taxable gift.
Asset gifts
Powerful tax-saving moves for families often use gift-tax provisions. Under current law, anyone can give anyone else up to $19,000 of assets annually, free of gift tax. That means a married couple with three grandchildren could give them a total of $114,000 in 2026.
The gifts can be cash or other assets, like stock. For noncash gifts, the cost basis—which is the starting point for measuring taxable gain after a sale—“carries over” to the recipient. So if someone buys $1,000 of stock and gives it away when it is worth $5,000, the recipient’s cost basis is $1,000. If the recipient later sells the shares for $8,000, the taxable gain is $7,000.
Here’s an example showing how gifts could save a family taxes. Grandma is a widow of modest means, while her child and spouse have prospered. The couple has two children, and they want to contribute $5,000 to a 529 college-savings plan for each—but they need to sell stock to do it. Their tax rate on the sale would be 18.8%, and they would need to sell about $11,000 of stock.
However, Grandma’s federal tax rate on the stock sale is 0%. If the couple gives $10,000 of shares to Grandma, she could sell them, pay no tax, and fund the grandchildren’s 529 plans. This saves about $1,000 of tax.
These moves are legal, and they could be used in other ways, such as to help a young person fund a Roth IRA.
But trust among family members is essential: Under the law, givers can’t put conditions on a gift. Grandma could use her stock proceeds to take a cruise, but she makes 529 contributions instead.
Mark Sellner, a retired tax attorney and CPA living in Sarasota, Fla., uses this strategy. His children sell stock he gives them and fund 529 plans for his grandchildren.
The family’s tax savings aren’t huge, but he likes other benefits. The sales by his children don’t boost his adjusted gross income, which in turn could raise his Medicare Irmaa premiums or his 3.8% surtax on net investment income.
Sellner doesn’t worry about his children using the funds for another purpose.
“There can’t be any strings attached to gifts. Of course, it is up to us to decide whether to make them in the future,” he says.
Two caveats: The “kiddie tax” applies to most children under age 24, and it is levied at the parents’ rate on investment income above $2,700 in 2026. Consider this before making gifts to a young person.
Investors who give away stock also forgo the step-up, an important provision that exempts assets held at death from capital-gains tax.
Sellner knows he’s losing a step-up, but says, “The children could use a little more now. Why should they wait 20 years to get it?”
Disclaimers
A disclaimer is a highly useful strategy in which one heir renounces an inheritance in favor of another heir. Assuming family members cooperate, this can save taxes.
Here’s one example. Dad died and had a large traditional IRA that he left to Mom. She has enough assets and income to cover her expenses, and she lives in a state with a stiff estate tax. The inherited IRA would put her estate over the threshold.
Also surviving are three young-adult children. If Mom disclaims all or part of Dad’s IRA within nine months of his death, that amount could go directly to the children. They will have 10 years to empty the account, and the family as a whole will likely save estate and income taxes.
Disclaimers have many key details, especially regarding beneficiary documents. Although heirs have great freedom in choosing what assets to disclaim, the rules about who gets disclaimed property are rigid. It is best if the original owner names tiers of heirs so that if one disclaims, the next recipient is clear.
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