Smaller Companies Feel the Chill of China’s Great Deleveraging

(Bloomberg) -- As China's great deleveraging kicks in, smaller companies appear to be already feeling the squeeze, judging by the latest factory gauge.

The manufacturing purchasing managers index pulled back slightly to 51.4 in July, propped up by improved sentiment among large firms. That masked a marked deterioration among small companies, with a sub gauge for them slumping to 48.9 from 50.1 in June, and a drop in mid-sized firms back below 50. Numbers under 50 indicate conditions are deteriorating.

That divergence suggests policy makers' curbs on excessive borrowing and shadow banking channels are putting the brakes on China's small and medium-sized companies, which provide most jobs in the nation yet often find it tough getting bank loans.

"The deleveraging campaign now is focused on curbing shadow banks, and the shadow banks help the smaller companies most," said Shen Jianguang, chief Asia economist at Mizuho Securities Asia Ltd. in Hong Kong. "Conditions for them will be even harder next year, when regulators are even more serious about cracking down on risks."

Growth in China's broad money supply was the slowest on record in June, and surging interbank lending rates have drained liquidity at smaller lenders. That stress is trickling down to their clients, usually SMEs, according to Shen.

A Standard Chartered Plc report last week showed smaller firms found it tough to get loans in July, according to a monthly survey of more than 500 companies.

Julian Evans-Pritchard, China economist at Capital Economics Ltd. in Singapore, has a different theory. He says the slowdown among smaller companies is because they are more sensitive to foreign demand, which is the main reason behind the PMI pullback in July.

Debt Curbs

As for the official line: chalk the PMI pullback down to unusually high temperatures in some areas, floods in others, and factory maintenance.

It's not all sunshine ahead for the state-owned companies, which traditionally have had easy access to all the credit they could need from the big state-owned banks. China should view curbing SOE leverage as "the priority of priorities," and hold officials accountable "for a lifetime" for building up regional debt, according to President Xi Jinping's remarks during a top financial regulators' meeting this month.

Read More: Xi Turns China's Deleveraging Cross-Hairs to Tougher Targets

"The economy in the second half will likely slow down gradually," said Ding Shuang, chief China economist at Standard Chartered Plc in Hong Kong. "With the deleveraging in process, we will see gradual lagged effects on the economy."

To contact Bloomberg News staff for this story: Xiaoqing Pi in Beijing at xpi1@bloomberg.net.

To contact the editors responsible for this story: Malcolm Scott at mscott23@bloomberg.net, Jeffrey Black at jblack25@bloomberg.net, Nasreen Seria

With assistance from Xiaoqing Pi