As the western market economies, in response to the 2008 financial crisis, have moved closer to state control of private finance, so China has moved closer to market-based finance for its newly private enterprises.
One of the great financial stories of our time is the awakened power of the Chinese worker. Much of that story is told in China's Superbank--but much that one might expect is also missing.
One wonders how an entire book on China's economic and trade development can avoid mentioning, even once, the names Walmart, Apple, John Deere, or any of the other global enterprises that so thoroughly depend on Chinese factories--and upon whom those factories depend for their revenues.
The answer is that Sanderson and Forsythe, two Bejing-based Bloomberg journalists, have sourced over 500 bond prospectuses for local government financing vehicles. The authors' interest lies in describing the restructuring of the Chinese state balance sheet and only indirectly in tracing the development of its income statement.
China Development Bank creates the Chinese powerhouse
In recent months, a virtual army of Western investment managers has raised the alarm about China's feared overspending on infrastructure. At the same time, many of these managers have preached the need for China to develop its domestic consumer market. This book explains how the Chinese political leadership is approaching the challenge, and how the leaders have tasked the China Development Bank with moving China from a rural to a semi-urban state in just 15 years.
For anyone who has taken in the glitzy skyscrapers and choked expressways in the megacities of the new China, this is a compelling story of supply-side (but still communist) domestic economics attempted without the benefit of a middle-class nor its traditions.
Sanderson and Forsythe have presented a worthy history of the role played by the China Development Bank in less than three decades of urbanization. A slim and highly readable volume, China's Superbank is more a series of essays tinted with prospectus statistics than the kind of in-depth analysis produced by the IMF or World Bank.
Although their beat is financial, Sanderson and Forsythe also give us vignettes of the human side of the economic explosion, from the disorientation of millions of displaced farmers to the headlong rush into venture capital and private equity of US-educated children--princelings of the revolutionary leadership.
Buildup to world banking power
After Chairman Deng Xiaoping pushed for market reforms after the Tiananmen Square protests, rampant inflation in the early 1990s led to strict budget laws that prevented local governments from running deficits or borrowing directly from overseas investors. The Asian financial crisis at the end of the decade led directly to the development of the "Wuhu Model" of finance, which Sanderson and Forsythe credit with transforming China from a rural Soviet, agri-industry economy into an urbanized, market-tilted model of state capitalism.
In essence, the Wuhu Model relies on phased land sales by local governments. These sales used special-purpose financing vehicles (LGFVs) to fund infrastructure investments and commercial development. Western bankers well know that approach to municipal finance, since the local government gains more tax revenue through the rise of market-driven economic activity.
However, the Chinese approach differs in that the local government can also sell nearby land as property values soar once enterprises bring projects to fruition.
Remember, the state owns all the land.
So the local People's Congress has two revenue sources for repaying the LGFVs: higher taxes and more land sales. That property values rose 140% in the dozen years after 1998 seems to cement the wisdom of the model. China Development Bank (CDB) legitimizes and guarantees the project with mezzanine financing, then the commercial banks take up the rest of the credit.
Sanderson and Forsythe recap China's efforts to tie down the energy resources needed to fuel its commercial revolution, through several mechanisms. These include the China-Africa Development Fund; loans for energy deals in Venezuela, Bolivia, and elsewhere; and investments in alternative energy firms financed with CDB lines of credit.
Marketing efforts of Chinese telecommunications firms are reinforced through deferred payments and below-market interest rates. For example, Huawei Technologies Company, the world's second-largest telephone maker after Ericsson AB, received a $10 billion commitment from CDB on Dec. 27, 2004.
According to China's Superbank, this was "the first of many CDB credit lines to its customers across the developing world that would allow it to gain significant market share. It was also the beginning of CDB's support of Chinese firms to ‘go global'."
One year later, Vodaphone Group, the world's largest mobile phone manufacturer at the time, appointed Huawei as its first Chinese-approved supplier of network equipment "and Huawei's road to global domination had begun."
By 2012, Huawei's success was being challenged in the European Union and elsewhere on the basis that its vendor financing represented an illegal government subsidy. Huawei retorted that Ericsson's customers benefited from similar arrangements through Sweden's export financing agency. However, the authors argue that state-owned CDB's ability to raise funds at sovereign rates distorts the competition.
"Only when CDB pays the proper price to get money and China liberalizes interest rates will it start to price its giant loans at market-based rates," they conclude.
Not your "friendly neighborhood banker"
And yet, despite China's global success, the authors paint a worrisome picture of subsistence farmers forcibly relocated to state-financed megacities without the prospect of gainful employment nor the skills to acquire productive jobs in commercial environment.
And who will be hurt if China's urbanization experiment fails?
Consider that the new apartments of the unemployed masses may have been built by LGFVs, but the largest investor groups were Chinese bank depositors. With few other choices, Chinese savers are captive to an economy where the state controls not just interest rates but also capital flows.
The authors complain that so little disclosure accompanies the financing activities of CDB that it's "a large black hole in global finance."
Since CDB is a political institution, not just a bank, its managers answer only to state shareholders. That structure may work against CDB and help the project finance teams of competing Western banks when facing off against CDB for projects.
As a result, "as much as it pushes into commercial, international deals for top-tier companies, it is held back by its origins," state the authors. "It still operates with a top-down hierarchy and an often time-consuming approval process. To some of those who work with the bank it can move at the speed of a government department rather than an international bank."
De-stating a state-run monolith
The greatest challenge to the WuHu model lies in the Chinese capability to move beyond creative financing for industrial outsourcing, as with CDB and Huawei, to the creation of brand identities for the ultimate consumer, in the way of Kia, Samsung, and other South Korean manufacturers.
It may be a long time before Chinese brands can compete with Chanel, Tiffany, Coach, and the other luxury retailers so evident in the fashionable districts of Beijing.
But only by lifting its pricing model can China's producers bear higher financing costs and still compete in domestic and export markets, while meeting the coming challenge to the low-cost model prompted by the growing demands of its waking labor classes.
How the superbank's top banker began
"Chen Yuan inherited a basket case. Always ambitious, from day one he was determined to change [China Development Bank] from a bureaucracy to a proper international bank. He introduced the idea of choosing projects, doing official credit appraisals and internal credit ratings, as well as many complicated procedures many in the bank apparently did not understand."
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