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Smaller businesses are proving to be a weak link in China’s economic recovery as they struggle to fully bounce back from the effects of Covid-19.

Like the U.S., China has tens of millions of small and medium-size private businesses, including restaurants and shops, which form the backbone of everyday economic activity. They account for as much as 80% of urban jobs and at least half of China’s tax revenue.

While businesses have benefited from China’s strong rebound this year, many are still trying to overcome weak consumer demand, rising operating costs and tight credit from banks that don’t want to sink more money into wounded companies.

Their struggles add a layer of uncertainty to China’s recovery. Many small businesses are reluctant to hire more workers, surveys show. Some say they are at risk of failing if conditions don’t improve substantially.

Close to 19% of China’s small businesses shut down last year, compared with 6.7% in 2019, according to a study released in March by Tsinghua University involving more than 50,000 companies nationwide.

While the insolvency rate is expected to be better this year, many companies still face serious cash-flow constraints. A survey of more than 10,000 small businesses released in March by Peking University and Ant Group Co. found that 15% have sufficient cash flow to sustain operations for six months or longer, down from 19% in the third quarter of 2020, though some expect revenue to pick up as the year progresses.

Liu Ning, a 49-year-old businesswoman who runs a marketing agency in Beijing, is among those who worry that they might not stay afloat much longer.

She said her firm laid off more than half of its 20-plus employees last spring to survive the pandemic, leaving only seven people. It received government support in the form of reductions in tax and social-welfare payments, though those measures have expired.

But business hasn’t fully returned. After being rejected by multiple banks for a business loan, she and her partner turned to online lenders charging high interest rates to avoid running out of cash.

“Covid hit us so hard that we are left with little power to fight back," she said, adding that her business is down by about two-thirds compared with pre-pandemic times.

China’s overall economic recovery remains on track, powered by global demand for Chinese goods, from laptops to toys. Gross domestic product surged a record 18.3% in the first quarter from a year earlier.

Yet some economists argue that China’s rebound might have peaked, with an unbalanced recovery continuing to create challenges. Although retail sales soared in March, consumer spending overall has been weaker than some economists expected. The latest survey of factory-owner sentiment suggests that economic activity might wane through the rest of the year, with Western consumers expected to shift more spending to services, such as restaurants, instead of imported goods.

A recent index released by the state-run Economic Daily newspaper and Postal Savings Bank of China found that smaller businesses haven’t returned to their pre-pandemic strength despite an improving economy this year. The index registered 44.3 in March, up 1.8 percentage points compared with last March. An index lower than 50 indicates a weakening business situation.

Higher raw-material costs and supply-chain bottlenecks are among the problems for manufacturers.

In the southeastern city of Rui’An, Ni Ni, owner of a factory that produces plastic buckles, said profit margins have been nearly wiped out by surging costs.

“We’ve been bleeding for months," said Ms. Ni, 44 years old, whose factory employs about 10 workers. If raw-material costs don’t come down soon, she said she plans to raise product prices or cut other costs.

Another concern for smaller businesses is the difficulty in obtaining credit. While there are signs that credit has become more widely available for some businesses, Beijing has restarted a deleveraging campaign—first begun before the pandemic—that is supposed to curb indebtedness and has resulted in tighter credit for many firms.

Zhang Lei, 32, who runs a consulting firm in the southwestern city of Nanning that helps developers build and sell homes, lost more than $150,000 in 2020 after several of his clients failed to pay him.

After letting go more than half of the staff, Mr. Zhang’s company was still short on cash. Loan applications were rejected by several banks, he said, mainly because he doesn’t own equipment or properties that can be pledged as collateral.

“It has been a year filled with anxiety," he said.

Xiaoxi Zhang, a Beijing-based analyst at research firm Gavekal Dragonomics, said government policies rolled out during the pandemic mostly benefited more-established small businesses with existing ties to banks. A recent crackdown on financial-technology platforms that have provided alternate sources of credit, including Ant, could further strain funding for small and medium-size enterprises, she said.

Authorities have pledged in recent months to expand credit for small businesses and otherwise help them recover. They have urged large banks to boost lending to SMEs by over 30% in 2021 and rolled out new tax breaks.

“We need to keep supporting small businesses to allow them to play a key role in stabilizing the job market," said China’s Premier Li Keqiang in March. He said the basis for China’s recovery isn’t yet solid.

Banks have responded up to a point. In a reversal from 2019 and 2020, small-business owners borrowed more than larger firms in the first quarter, according to China Beige Book, a data-gathering firm that conducts surveys among Chinese businesses. But smaller businesses still pay marginally higher rates, and some analysts question whether banks are genuinely willing to do more.

Government authorities “want Chinese banks and financial institutions to help the SMEs by backing them. But the banks themselves do view them as a riskier space," said Ron Thompson, head of the Asia restructuring practice at Alvarez & Marsal, a professional-services firm.

For some businesses, the biggest threat comes from people who are still worried about Covid-19 and the state of the economy and who are unwilling to spend as freely as they used to.

Wang Limin, who runs a snack shop selling duck necks in downtown Beijing, said customers have been more cautious about spending. Even though foot traffic has picked up, “our sales this year haven’t been as good as last year’s," he said.

On the same street, Zhang Lu said his hair salon lost 20% of its income because of the pandemic last year.

“Fewer people dye and perm their hair," said Mr. Zhang, 33. “They are less generous with money now."

This story has been published from a wire agency feed without modifications to the text.

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