This article was first published in the May 2012 China edition of Accounting and Business magazine.
When Hong Kong’s financial secretary John Tsang delivered his 2012–13 Budget speech in February, supporting small and medium-sized enterprises (SMEs) was at the top of his list of proposals.
While the government expects the domestic economy to grow by only between 1% to 3% this year, and with the global economy recovering slowly from the financial tsunami of 2008–09, Hong Kong businesses are in for another tough year, and the SME sector is likely to be the hardest hit. With the approximately 300,000 SMEs in Hong Kong employing more than 1.2 million people – about half of the private sector’s working population – their performance is crucial for the city.
‘I am deeply concerned about the possible hardship SMEs may suffer in times of economic downturn,’ Tsang said in his speech. ‘We must do our utmost to help SMEs get through difficult times in order to minimise unemployment.’
Retail sales in Hong Kong were robust in 2011, with a 25% increase from the previous year, largely due to a 24% increase in the number of mainland Chinese shoppers visiting the region, according to the Nielsen Commercial Financial Monitor. However, business confidence among SMEs in 2011 fell by 12 index points to 96 index points year on year. Also, 58% of SMEs said they expect a slowdown in this year’s business environment due to the fragile and volatile global market’s conditions, Nielsen reported.
‘They are not optimistic and it is not difficult to understand why,’ says Tracy Ho, a tax and business advisory services partner at Ernst & Young. ‘Exports of goods have fallen since mid-2011, China has adjusted its GDP [gross domestic product] growth to below 8% and, with the eurozone crisis, what is certain now is the outlook is uncertain.’
Hong Kong is, above all, a trading city. About 40% of its goods and services are sold to international markets, well above the global average of 29% for countries exporting their output, according to HSBC’s estimates. So when the global economy falters, most of Hong Kong’s businesses feel it.
Since the global financial crisis three years ago, many SMEs have struggled to cope with reduced orders and also increases in credit defaults among their overseas customers, says Jennifer Wong, a tax partner at KPMG China. ‘I have come across clients who are writing off their bad debts,’ she says. ‘Many of them are working hard to chase after their creditors, but many of their customers have been placed into administration and liquidation.’
Albert Chan, head of HSBC’s commercial banking in Hong Kong, says that, due to falling export markets, Hong Kong’s SMEs are now borrowing mainly for working capital purposes, such as paying for electricity, salaries and bridging between receivables and payables. ‘A few years ago, we handled a lot of investment into China to set up new factories, infrastructure, and so on. Recently, we do not see that happening significantly,’ he says.
Customer concern
Added to this, export orders for manufactured goods have been down for the past five years, reports Danny Lau, chairman of the Hong Kong Small and Medium Enterprises Association. Worryingly, many of their overseas customers last year insisted on making smaller and more frequent orders. Rather than placing one or two large orders for the year, customers made up to six smaller ones, resulting in greater risk for suppliers and fewer opportunities for economies of scale. In response, Edward Lam, CEO of clothing wholesaler Delicron, has been cutting capital expenditure and keeping a tight control of the company’s inventory and staff headcount while putting the profits it earns into long-term deposits.
Lau says that, for Hong Kong’s SME manufacturers, this year will hinge largely on a recovery in the US economy. ‘A lot of figures, such as [for] unemployment and new housing, show the US market is recovering,’ he says. ‘In the second half of this year, there should be more orders.’
While the US recovers slowly and Europe’s economy remains uncertain, China’s fast-growing market holds many attractions for Hong Kong exporters. However, it is often a difficult and risky place to do business, especially for an SME with little clout in the mainland’s legal system.
‘China is a huge market. But how much can an SME afford to invest in opening stores there?’ Lau asks. ‘And if you do wholesale, you have to give credit to your dealers and trust them. What happens if they don’t pay you?’
In addition to dealing with unstable markets, many SMEs have to cope with higher costs. In particular, rents for office spaces and retail shops in the city have been rising steeply.
‘For retail and restaurant owners, their rent has gone up dramatically over the last five years,’ Lau says. ‘For some, rents recently went up by 100% when their five-year leases ran out.’
‘Rental is definitely rising in Hong Kong,’ says Rhonda Gretton, owner of the retail barbecue business Jervisbay Barbecue World. ‘We are about to move our offices out of Central, closer to our retail outlet in Horizon Plaza,’ she says. ‘But even then we are finding the rentals in the Aberdeen area are rising fast.’
Meanwhile, Hong Kong’s SME manufacturers with factories in China are being hit with increases in wages, the price of raw materials and an appreciating renminbi currency. ‘In the Dongguan area, a lot of the factories of the SMEs have had to close. They cannot cope with the rising prices,’ Wong says.
Government support
Reactions to the range of proposals in the Hong Kong government’s 2012–13 Budget, which aims to help SMEs survive a downturn, have been mixed. Plans include a one-off corporate tax rebate, waiving business registration fees, and offering SMEs special concessions on insuring their exported goods and services. ‘All added together, it would be a sum appreciated by the SMEs,’ says Ho. ‘Better than nothing,’ is Wong’s verdict.
The government’s proposals to lift the maximum loan guarantee ratio to 80% and reduce the guarantee fees for the SME Financing Guarantee Scheme, which was launched in January 2011, came in for particular attention.
Chan believes that the two measures will make the scheme much more popular among SMEs and encourage banks to lend more to them. ‘A 10 percentage point increase in the guarantee is quite a material change, so I think that will trigger a lot more participation from the banking industry,’ he says.
However, some SMEs remain sceptical about a scheme where banks decide which enterprises will gain access to the government-backed finance, and object to their credit control tests.
‘Some SMEs say if they can pass this test, they could easily borrow and don’t need the government’s assistance,’ Wong says.
According to Gretton, some banks are reluctant to become involved with the scheme. ‘I changed my bank because I had been with it for 35 years and we could not get a person to even begin to implement the deal,’ she says.
Beyond the Financing Guarantee Scheme, there are many other grants and schemes available to Hong Kong’s SMEs, and many are aimed at helping with research and development projects and business expansion. The trouble is that there is a general lack of awareness about the schemes, and the application process can be long for a cash-strapped business.
‘SMEs need to find a way to access the government funding,’ Chan says. ‘My view is there is room for wider promotion, because a lot of SMEs are not fully aware there are funds available for them and how to make the applications.’
However, Chan adds that placing a list of schemes available to SMEs on the Hong Kong Productivity Council’s website has been a step in the right direction.
*Government Support for SMEs in 2012–13
The Hong Kong government is:
Increasing the existing SME Financing Guarantee Scheme’s maximum loan guarantee ratio from 70% to 80%; lowering the guarantee fee for borrowers.
Offering special concessions and premium discounts to SMEs, insuring their exports through the Hong Kong Export Credit Insurance Corporation.
- Waiving business registration fees for 2012–13.
- Reducing profits tax for 2011–12 by 75%, capped at $12,000.
- Halving import and export declaration duties; abolishing capital duty levied on local companies.
- What the IASB is doing for SMEs
Mindful that the International Financial Reporting Standards (IFRS) were placing a heavy burden on the SME sector, the International Accounting Standards Board (IASB) released a separate standard for these entities’ financial reports in 2009 that is less complex than the standards applied to larger companies. The result is a standard of just 230 pages, or about 10% of the full IFRS.
In Hong Kong, private local companies can use this standard if they have no public accountability – they have not and are not planning to issue equity or debt instruments for trade on a public market, or hold assets in a fiduciary capacity for a broad group of outsiders as one of their primary businesses – and issue financial statements for external users. Overseas companies in Hong Kong can apply the SME standard if they fulfil at least two of the following three criteria: generate revenue below HK$50m; hold total assets below HK$50m; and have a maximum of 50 employees.
Since the SME standard was released three years ago, the IASB has been issuing changes to its question-and-answer series to help clarify some implementation issues, and is planning to start a comprehensive post-implementation review of the standard during the second half of 2012.
Furthermore, amendments to the full IFRS on revenue, leases and financial instruments may soon also have a knock-on effect on the SME standard, says Yin Toa Lee, financial services leader for Asia Pacific Financial Accounting Advisory Services at Ernst & Young.
If Yin could change one thing about how the SME standard is applied in Hong Kong, it would be to have more education and training on it made available to lenders and creditors. ‘Ultimately, they are the ones who will be basing their decisions on these financial statements,’ he explains.
Bruce Andrews, journalist