In China’s statist turn in 2003-05, a second pillar of the state economy “inside the system” was created by the state-owned China Development Bank (CDB). Chen Yuan, the princeling son of Chen Yun, who was the planner and architect of the mixed economy, converted this bankrupt institution into the main instrument for channeling China’s infrastructure spending, as well as a major instrument of China’s economic foreign policy. China’s Super bank, an important book by two China-based Bloomberg journalists, Henry Sanderson and Michael Forsythe, dissects this story.
Chen Yuan converted the CDB in 1998 into a financial conduit for China’s infrastructure spending by using the financial instruments created in the local competition of the xians (which had promoted the foreign direct investment-based non-state sector in the first decade of China’s economic rise). Realizing that China’s urbanization was raising the price of land, and the xians that owned the land could collateralize these land revenues — which also, being extra-budgetary revenue, had no oversight over their use — Mr Chen devised a CDB system “to leverage the future value of land into large upfront loans, such as one it gave the port city of Tianjin in 2003”.
Unlike the commercial banks, the CDB could not accept deposits — nor after Zhu Rongji’s tax reforms could the local governments, which were forbidden from running deficits or issuing bonds. So Mr Chen created the following system. The CDB sold its bonds to the commercial banks, financed through their deposits. The CDB then helped local governments set up companies to borrow (local government financial vehicles, or LGFVs), and gave them initial long-term loans. “Thus dressed up and empowered, the LGFVs were free to go on a further borrowing spree seeking short-term loans from the commercial banks or selling bonds themselves on the bond market to banks and securities companies. If the central government wanted to stimulate the economy, it could send money flowing down this cash waterfall. The risk in the end came back to their front door”.
In two years from 2008, total bank lending to LGFVs rose by over three trillion yuan ($488 billion). Between 2009 and 2010, China’s total government debt grew at the same speed as the US in the five years before its housing crash in 2007, and like US subprime debt “these off-balance sheet vehicles have infected the balance sheets of all China’s major banks”. The first cracks in the system appeared when land prices began to fall in 2011, and the LGFVs could not pay back the principal or even the interest on their borrowings. So banks were ordered by China’s Banking Regulatory Commission to roll over their short-term LGFV bank debt, making these loans illiquid.
The LGFV model also required local governments to acquire land cheaply and sell it at a profit, which they did by expropriating farmers’ land and expanding cities into rural areas, leading to widespread protests with “60 per cent of all large-scale protests … due to land grabs and compensation disputes”.
China has taken a huge gamble that the infrastructure created by the CDB model would raise growth, which will raise incomes, which will pay for the debt through which this infrastructure has been financed. As the CDB bonds bought by the commercial banks are based on negative real interest rates on deposits for savers, “if the infrastructure build-out is not efficient, it wouldn’t be a stretch to say China’s savers have been robbed”.
But Mr Chen had wider ambitions. With the collapse of the Western banking system in 2008, he extended his collateralized land-based model, which had funded all the grandiose projects from the Three Gorges dam to the Olympic stadia, metros and highways within China, to the Third World. The CDB would give large loans to the state enterprises owning natural resources in Africa and Latin America. The loans were collateralized on future deliveries of natural resources to Chinese state-owned companies. The proceeds of the loans are used “to buy Chinese goods and service from Huawei phones to CITIC-built railroads. China wins twice, and CDB helps foster another Chinese goal, pushing its top companies to ‘go out’ and become globally competitive multinationals”. Most of these “companies are state-owned, and almost all are long-term clients of CDB”.
Venezuela epitomizes this development model. Consider the case of Chery Automobile, nurtured by a CDB-established LGFV in Wuhu and guided abroad with CDB loans. Six Chinese state-owned companies have won over a quarter of the total government-tied contracts to the CDB since 2008. This CDB lending has been enormous. From “being almost nothing prior to 2008 … in 2010 its loan commitments were more than those of the World Bank, Inter-American Development Bank and the US Export-Import Bank combined… .[T]he model is also used around the globe, from Russia, to Ghana to Turkmenistan, as a means to secure energy supplies and for its state-owned infrastructure companies to win contracts. China’s money is secured by winning business for Chinese companies, rather than setting policy conditions on the borrowing country”.
Though China through the CDB is attempting to use its growing economic strength as an instrument of its foreign policy, “the problem, like that of the rows of empty skyscrapers now dotting the Tianjin skyline, is one of hubris. In the case of local government debt, CDB might be guilty of ignoring basic laws of supply and demand. In Venezuela, it may be ignoring history…. Does China, with the CDB as its executor, really believe it is immune from two centuries of Venezuelan debt defaults?”. For, with a turn in the political wheel, third-world governments might appeal to the emerging internationally accepted norm of “odious debt”. After the fall of Saddam Hussein, the new Iraqi government won forgiveness of much of the debt incurred by the despot on this argument.
Equally worrying for the Chinese government is that this CDB model is increasingly facing a backlash, particularly in Africa, for being a new form of neo-colonialism (see my book Poverty and Progress). Will the Chinese be willing and able to use “gunships and Gurkhas” to protect these investments like the imperial powers of yore?
The CDB is an extension of the Chinese state and the Communist Party, which has garnered all of China’s household savings through financial repression. If the CDB’s gamble on infrastructure spending through its LGFV vehicles does not pay off, and the gambles it has taken on the political stability of the many “odious” regimes it has financed through loans for natural resource loans in the Third World fail, these households will see their savings turn to ashes. I will examine the viability of this statist debt-fuelled model in my next column.