China Development Bank is the core policy bank in China. It has more than Rmb 6tn ($984bn) in assets, is wholly owned by the state and is as good for its money as the government itself. So when CDB is forced to cut the size of a proposed bond issue by 60 per cent, as happened this month, you can be sure something is not right in China’s credit markets.
Other respected and credible companies have also been forced to delay or reduce bond issues, or pay more for their money. Take US-listed internet group Baidu. Last year, it sold a bond to US investors that was priced without the extra that emerging market borrowers usually pay. But in recent months, it struggled to get a Chinese bond away.
China’s cost of capital has begun to rise even though the government seems some way from the liberalisation of deposit rates that has held down borrowing costs for so long. Banks must already pay more for funds in the interbank market. Meanwhile, wealth management products (WMPs) – short-term savings products sold mostly by banks to retail and institutional investors – and trust products continue to grow. Both are currently offering better returns than straight corporate bonds to all investors, including banks themselves.
The issue here is less about the rising cost of money – which is inevitable as markets come to play a “decisive” role in China, as the post-Plenum buzzword has it – than it is about bad policy, or at least the consequences of slow policy.
With financial reform, Beijing may be gracefully “crossing the river by feeling the stones” as advocated by the late Deng Xiaoping, but it is simultaneously turning a blind eye to jerry-rigged fording devices, like WMPs, just down stream.
Plenty of ink has been spilled on the risks tied up in WMPs, but much less on what they are really there to do. Their role is to begin to allow market forces to affect the cost of money for banks and companies ahead of interest rate reform; WMPs also legitimise investments that have not yet been officially approved, or are banned in banking channels. They do this simply by being an intermediary, or wrapper around the banned products.
Hence, they have been used to supply high-cost capital to property developers, as well as some state-owned enterprises. More recently, they have moved on to investing in hedge funds. Managers and their friends or family put up the first chunk of equity, then WMPs add up to four times that in leverage, say Shanghai hedge fund specialists. This allows insurers, for example, to indirectly invest in funds that officially they should not.
One of the great oddities in Chinese financial policy is that liberalisation happens as much negatively as positively. Companies like the financial arm of ecommerce group Alibaba have found that the way to develop products is often to start using them and see if someone tells you to stop. It can lend to small businesses but was warned away from early trials of consumer loans.
Financial innovation is rarely given preapproval, bankers say. The industry is forced to “feel the stones” in the absence of clear policy. Surely Deng’s metaphor was about discovering what works, not what would gain official sanction.
Viewed optimistically, WMPs have introduced a market for funding, lending and investing that ought to help banks and others learn to assess risks and to balance changeable costs and returns. However, their role in legitimising not yet sanctioned, or already banned, activities just adds to the inefficiency and costs in the distribution of Chinese capital.
The power of each new yuan to generate economic growth is waning. The leakage of costs through extra layers of WMPs makes this worse. China’s cost of capital will rise, but it does not have to rise that much. Interest costs track gross domestic product growth rates, according to Bernstein Research. If China grows at 6-7 per cent for the next few years, new debt ought not to cost much more – so long as it is dispensed reasonably efficiently.
For this to happen, the single most important reform would be market pricing of deposit rates. This will be dangerous for banks, as Jiang Jianqing, head of ICBC, China’s biggest bank, told the FT recently: “If you do badly, you will be wiped out.”
But finance keeps moving away from official channels – around one-fifth of credit was formed outside of banks in 2009; now that share has doubled, according to Bernstein. To protect the banks, Beijing must move slowly; but if it moves too slowly, good companies could be starved of reasonable funding – and it runs the risk that China’s financial river will end up clogged with the detritus of too many bad experiments outside the banks.
Paul J Davies is Asia Finance Correspondent
中国国家开发银行(China Development Bank)是中国最重要的政策性银行。它拥有超过6万亿元人民币(9840亿美元)的资产，为全资国有银行，信用与政府相当。因此，本月当国开行被迫将拟定的债券发行量削减60%时，可以肯定中国的信贷市场出了问题。
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