All signs herald a difficult year for Chinese companies

Judging by the latest reports from Chinese companies, the world's second-largest economy still has a long way to go.

Take the revenue reports of the country's technology giants in recent weeks:

On Monday, China's National Bureau of Statistics said industrial profits fell 3.4 percent in the first four months of this year.

"Frankly, there are not many items that look particularly brilliant," said Thomas Gatley, an analyst at Gavekal Investment Research Company in Beijing, during a talk last week. about his record of the last season of results. "It's going to be a difficult year."

Since last summer, the Chinese government has announced a series of measures to stimulate growth. Although these have prevented the situation from worsening, it is unclear whether they have been sufficient to stimulate the economy significantly. The country faces a host of unresolved internal problems, not to mention the growing pressure from its largest trading partner, the United States.

In the Morgan Stanley MSCI China companies' valuation, analysts said earlier this month that some quarterly results exceeded expectations for the first time in at least 12 months. But they were cautious about the way forward, "given the rising trade tensions between the US and China, as well as the recent macroeconomic weakness reflected in the April data."

One of Beijing's strategies for stimulating growth is to increase the availability of financing for private companies.

Private companies are key to China's economic and social wellbeing as they contribute to 90% of new jobs and 70% of technological innovations and new products, according to the news agency. State of Xinhua. And for a country controlled by one party, the maintenance of social stability is essential.

Since the largest Chinese banks are owned by the state, they prefer to lend to other public enterprises. This leaves most private companies with less transparent funding channels. Beijing cracked down on this funding early last year as part of an attempt to curb the swelling of unspent debt.

Even before that, small businesses were going through a difficult period. According to a Boston Consulting Group report, Chinese small and medium-sized enterprises have an average life of 2.9 years, compared to seven years in the United States and 12 years in Japan.

Mr. Gatley also pointed out that a higher percentage of Chinese publicly traded and non-listed companies derive profits from abroad, making them more vulnerable to growing trade tensions with the United States.

With the slowdown in growth, the government announced significant tax cuts and fees and repeatedly ordered banks to lend more to private companies, especially small businesses.

Some of these efforts have paid off. Gavekal's analysis showed that cash flows from private enterprise financing increased in the first quarter of this year, after virtually being zero in the fourth quarter of last year.

However, the opening of funding sources – whether from banks or private companies – does not necessarily translate into a sustainable recovery in growth.

Given the lack of reliable credit information, financial institutions are still struggling to determine which companies are worth lending, said Duo Yuan, founder of Bluestone Asset Management, based in Beijing.

"The Chinese credit market is far from mature and some private companies, after obtaining private equity funds, play tricks while trying not to pay their debts to investors even when they have money, "he said in a statement in the English language. "And because of the lack of legislation in this area, these companies are not even fined.The consequence is that fewer financial institutions dare to buy bonds issued by private companies."

Incidents involving two companies in recent weeks have highlighted weaknesses in Chinese governance.

Drug maker Kangmei Pharmaceutical said late April that an "accounting error" had resulted in an overestimation of liquidity in 2017 of 29.94 billion yuan (4.4 billion US dollars). On May 20, the company also announced that it had transferred nearly 8.9 billion yuan to related entities in order to trade its own shares. Kangmei is part of the MSCI China Index, released during the review last summer. It remains to be seen what punitive measures could be taken by regulators beyond delisting.

Also in late April, the composite materials group Kangde Xin said in its first quarter report that there was no record of 12.21 billion yuan that the company claimed to hold in a bank deposit. Earlier in the year, the company missed interest payments and defaulted on its debts. Local police have taken action against the company's controller, Caixin reported in mid-May, citing a vague message written on Weibo, the Chinese version of Twitter.

The Bluestone Duo said that investors have long been concerned about the ability to recover their money from private companies based in northeastern China, to the point that there is a Chinese saying that says that "investments should not go beyond Shanhaiguan". The phrase refers to an important passage from the Great Wall to the east of Beijing.

Last week, the Shenzhen Stock Exchange revealed on its website that its department responsible for overseeing small and medium-sized enterprises had opened an investigation into Zhangzidao's annual report of 2018, a fishing company based in the city of Dalian, China. northeast of the country.

In recent years, the company has raised eyebrows about the massive financial losses suffered by missing or dead scallops. Zhangzidao has until Wednesday to answer, according to the record. Company representatives did not immediately respond to a request for comment from the CNBC.

"The risk of fraud remains huge in the Chinese market," said Gatley. "(There is) pure criminality at one end, then companies that do things that do not seem to be business."

"There are important and very difficult vulnerabilities below the surface," he added.

On the bank side, government lending requirements for private enterprises could also introduce more risk into the system.

"I actually think that banks should not be asked to lend to a particular sector, private or (state) companies," said Weijian Shan, CEO and managing partner of the investment company PAG, in a email. "Banks should make their own credit decisions based on the creditworthiness of borrowers.With the risk management systems in place in Chinese banks since the banking system reform of the early 2000s, they should probably not not achieve the policy objectives of supporting borrowers with low credit anyway, that's not a bad thing. "

Shan added that he expects that if a company has a reasonable credit record, it should not have any trouble getting financing.

China remains one of the fastest growing economies in the world and analysts see opportunities in areas such as the country's smaller cities. China's official gross domestic product (although often in doubt) rose 6.4% in the first quarter, unchanged from the previous quarter but down from 6.8% a year earlier before. Authorities predict slower growth of 6% to 6.5% this year.

With a state-controlled economy like that of China, the authorities have shown that they could organize a recovery. The question, for Gatley, is: "Once the immediate crisis has passed, how (for how long will Beijing stay) will the pressure be maintained?"