September 21, 2015 / 9:01 PM / 2 years ago

China rate cuts bypass business heart of economy

* Small businesses feel the strain as economy slows

* Central bank rate cuts help big firms, not small ones

* In contrast, lending rates for small firms have risen

* New loans to small businesses are falling

* Underlines concerns about health of China economy

By Umesh Desai

HONG KONG, Sept 22 (Reuters) - For Wu Yinghua, an executive at a mid-sized optical disc company in China, business has never been so bad.

The problem is, conditions for Wu's company and others like it in the small and medium business sector are only getting worse - despite government efforts to lift the economy.

Small and medium enterprises (SMEs) are already the heart of China's economy, providing 80 percent of urban employment and 60 percent of GDP. But the country's financial infrastructure is largely geared to state firms.

So although China has announced a volley of rate cuts to stabilise its battered stock market and reverse a slowdown in growth, SMEs are experiencing little or no benefit, underlining concerns about the world's second-biggest economy.

"We have been in the optical disc business for more than 20 years and the recent depression is the most serious challenge we have ever faced," said Wu, an executive at Guangdong Aolin Magnetic Electric Industrial in southern China.

The central bank has cut official lending rates five times since November by a total of 1.4 percentage points to 4.6 percent. But instead of falling, lending rates to SMEs have risen by 2 percentage points as willing lenders become scarce.

The Wenzhou index, which tracks private lending, shows the rate for 1 year or more has risen to 18 percent from around 16 percent in November. In April, rates were as high as 24 percent.

The state-dominated banking sector has become more selective in issuing loans in general, as non-performing loans increase in the economic slowdown. China's big-four banks all reported a rise in non-performing loans in the latest quarter.

China's economy is heading for its weakest growth in 25 years, and a recent run of poor data suggests it is struggling to meet its 7 percent target for 2015.

So only the brave are stepping in to lend to its most vulnerable firms - small, medium and micro businesses. That is reflected in central bank figures showing that while overall lending in China has risen, new loans to small businesses fell in the first half of the calendar year compared with the same period in 2014.

"We have seen a surge in enquiries," said Barry Lau, co-founder and managing partner of Adamas Asset Management in Hong Kong, which provides funding for growth enterprises in China and has $650 million of assets under management.

SMEs can turn to the non-bank-sector, the so-called shadow banking sector, but even there, lenders are becoming more prudent, said Wilson Pang, a partner at KPMG in Hong Kong.

"Those who were asking for interest rates of 12-15 percent are now asking for 20-22 percent, or even more, because of the slowdown," Pang said.

SHUT OUT

Oliver Barron, policy research analyst at China-focused investment bank NSBO, said the main beneficiaries of the monetary easing were state-owned enterprises and local government finance vehicles.

"Weak bank lending and tightening of off-balance sheet lending through acceptance bills etc are pointing to lesser access for the SME sector," Barron said.

Another deterrent for small businesses is that applying for a loan has become more cumbersome.

"The covenants are tighter than before and the vetting process is getting tighter," said Roy Wang, a restaurant owner in the southern city of Shenzhen.

"The banks need to check records which they did not check before, like history of the company, financial records of the company and the shareholders," Wang said.

Underlining the strain on smaller companies, Mizuho's chief economist for Asia ex-Japan, Kevin Lai, said China's economy needs to grow at 8 percent a year just for large corporations to keep up with interest payments on the country's mountain of debt. And that's based on a lending rate of 6.5 percent.

"SMEs are paying more than 16 percent. Which business gives that kind of return? Are they making that kind of money?" he said.

The economic slowdown is stoking calls for authorities to make funding conditions even easier, but that might not help many small firms.

"This is really a tough period," said Alex Gu, marketing manager at Suzhou Realpower Electric Appliance.

"For the big enterprises who own core technology, they may get over it. But for some SMEs, they may have to merge." (Additional reporting by Emma Yang and Adelaide Hui in HONG KONG; Editing by Anne Marie Roantree and Neil Fullick)

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