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«China Development Bank’s Strategy and its implications for Brazil Albert Keidel1 and Leonardo Burlamaqui2 Paper prepared for the MINDS Conference ...»

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Keidel and Burlamaqui- MINDS Conference

China Development Bank’s Strategy

and its implications for Brazil

Albert Keidel1 and Leonardo Burlamaqui2

Paper prepared for the MINDS Conference on the Present and Future of Development Financial

Institutions – Rio de Janeiro, July 28-29, 2014.

1

Adjunct Professor, Georgetown University, D.C.Non-resident Senior Fellow at the Atlantic Council of the United

States.

2

Associate Professor, University of the State of Rio de Janeiro. Research Scholar at the Levy Institute, NY.

1 Keidel and Burlamaqui- MINDS Conference Contents Executive Summary 3

1. Introduction: A snapshot of the Chinese Banking System 5

2. The Emergence and Maturing of the China Development Bank 9

3. CDB’s Global Strategy 12 3.1- Africa: Funding infrastructure and Chinese direct investment 13 3.2- Reducing uncertainty: Loans-for-Oil Worldwide 14 3.3- Funding Chinese Global Players 16

4. The Efficiency of, and Unwarranted Opposition to, Government-owned Banks 18

5. Implications for Brazil 20 6- Conclusion: Questions, Policy Recommendations, and Institutional Restructuring 28 Bibliography 35 2 Keidel and Burlamaqui- MINDS Conference Executive Summary China Development Bank (CDB) is an example of a well-functioning government- owned development bank. Many development banks in other countries perform poorly. CDB shows that a government bank like CDB is a critical component of economic development success. The important issue is not whether a poor country with a weak tax base should have a development bank. In important ways, all growing economies need a government development bank. What matters is whether the development bank is effective or not.

A number of academic studies have purported to prove that government-owned banks, including development banks, are associated with slower growth. Careful examination shows these studies’ general conclusions are not consistent with their statistical results. The right lesson about growth and government banks is that some do and some don’t associate with faster growth. The focus should be on what causes the difference between good and bad development banks. CDB proves that a government-owned development bank can be extraordinarily effective, and it offers examples of how this can be accomplished.

In considering CDB’s strategy, it is important to emphasize that it is not just CDB’s strategy that matters. CDB is part of a broader governance strategy shaping the overall financial system so that CDB is effective. Because of this combination of CDB and its enabling environment, the overall financial system – including its private sector – is more efficient and more profitable than it would be without CDB and the other policies that support CDB’s operations.

By itself, CDB’s effective strategy has been to combine a wide range of techniques and instruments, in an enabling financial environment, to support highly productive public and other long-term investments that would otherwise go unfunded. This is the essence of overall financial efficiency – directing funds saved in many parts of the economy to their most productive and beneficial uses. Private-sector financial systems by themselves are inefficient, because they neglect public investments and fail to accomplish this optimal intermediation result.

The implications for Brazil are these: CDB is proof that development banks can be critical contributor to rapid growth. Recent IMF reviews of the Brazilian economy and its prospects paint a pessimistic picture – essentially a picture of development failure, with percapita GDP growth for the long-term of roughly 2½ percent. Brazil must find additional ways to raise its investment share in GDP and within investment the share that goes for publicgoods investment like infrastructure. If Brazil reforms its financial system, including BNDES, in the direction of capabilities enjoyed by CDB, Brazil could accelerate growth, reduce

3 Keidel and Burlamaqui- MINDS Conference

instabilities, and enhance both productivity and profits in the private sector. CDB is a successful demonstration of development finance, including specific techniques and a broad enabling financial environment. It shows Brazil possible directions that future reforms can take to enhance BNDES’ development significance and the efficiency of Brazil’s overall financial system.

The major challenge to a Brazilian attempt to introduce lessons from CDB’s success would be the initial implications for and resistance from Brazil’s private financial sector. Private financial institutions would see a greatly enlarged BNDES and related appropriate financial reforms as potentially threatening. In fact, however, a successful expansion and reorientation of BNDES and Brazil’s other government-owned banks would generate a more profitable Brazil for the private financial sector in just a few years because of the implications for rapid growth and increased financial activity across the board.

***

–  –  –

1- Introduction: A snapshot of the Chinese Banking System The 1980s had very little market-based finance and left China’s public and commercial finances deep in red ink for the 1990s to have to deal with. The 1980s and early 1990s were a time of crude post-command-system fiscal and financial reform in which state enterprises were extracted from the national budget and China’s four major state commercial banks were created out of the one large single state bank that in Mao Zedong’s last decade had been merely a disbursing department in the Ministry of Finance. As a result, even after these early reforms, the operational distinctions between banks, budgets and enterprises were blurred, and the differences between loans, profits and state assistance to enterprises had only gradually begun to take shape.





However, these apparently crude financial shortcomings in the 1980s and early 1990s were in many ways fit for the China’s development stage at that point. They allowed the economy to grow and reduce poverty despite the system’s blaring shortcomings. For example, China’s price system wasn’t suitable for reasonable market-based management decisions – either in the financial sector or in industrial and commercial sectors. Many urban enterprises, all effectively owned by the state, had surplus and low-productivity workers at a time when China had no effective labor market to reallocate workers according to market principles. A great deal of urban infrastructure, including roads, schools and healthcare facilities were financed by state enterprises under direction from a combination of relevant central and local authorities. Rural markets had become increasingly independent of the planned system, and inflation from rural competition, expanding rural productivity and rural demand placed increasingly severe pressures on urban household finances.

Under such circumstances, an amalgamated financial design combining public and private operations kept some control over what could have been, and sometimes became, highly disruptive and damaging social tensions and conflict. The Tiananmen demonstrations of 1989 were the most powerful example of the fundamental disequilibrium in China’s economy as it traveled the difficult transition road between Maoism and the State-sponsored-market oriented developmental strategy under Deng.

In banking terms, the 1980s and early 1990s didn’t differentiate between state-owned commercial banking and development banking. There were no formal development banks, so each of the four major state-owned commercial banks was in fact a development bank as well, making loans for strategic public projects, propping up the finances of state firms with excess labor, subsidizing product prices lower than unit costs, or sustaining production of products that didn’t sell.

5 Keidel and Burlamaqui- MINDS Conference

The hangover from this 1980s amalgam of bank, budget and enterprise financing was a huge accumulation of non-performing loans on the books of state-owned banks, matched by a correspondingly large accumulation of bank debt on the books of state enterprises. The largest number of these loans were called bogaidai (a Chinese acronym for “budget disbursements converted to bank loans”) because in the early 1980s when state firms were separated from inclusion in government budgets, they still needed money. They got it in the form of bank “loans” which many firms had no intentions, or means, of ever repaying.

The framework of China’s current financial system was initiated in the early 1990s as a conscious program for eliminating the bogaidai loans from balance sheets of both banks and enterprises. The process of establishing a legal basis for these reforms gathered momentum with the passage by the National People’s Congress (NPC) of a central bank law, a commercial bank law and a company law. China in the mid-1990s created so-called policy banks, for agriculture, foreign trade and domestic infrastructure, as a way of relieving commercial banks of the burden of making government policy-directed loans – which continued on a large scale nevertheless (Keidel:2007, p.1). As for financial regulation, the Chinese system is lean and quite straightforward. The financial sector is regulated by the People’s Bank of China (PBOC), China’s central bank3, and/or three commissions: the regulatory commissions for banking, securities and insurance.

The banking sector falls under the supervision of the People’s Bank of China and the China Banking Regulatory Commission (Cousin: 2011, p.21). The China Banking Regulatory Commission (CBRC) was established in March 2003 with the aim of increasing the independence of the central bank and, especially, making the regulatory function of financial institutions more robust. The CBRC is the supervisor of financial institutions under the leadership of the State Council, which is China’s executive. It turned out to be a key player in the guidance of the financial system through reform and recapitalization in the latter 1990s and, even more, in preventing China’s financial system from diving into the kind of “casino capitalism” that had been thriving in the US and all over Europe since the eighties 4. Lardy

affirms this very clearly:

“Most obviously, since China's financial regulatory agencies had steadfastly refused to permit the creation of complex derivative products in the domestic market and severely limited financial institutions' exposure to foreign sources of these products, Chinese financial institutions had little exposure to toxic financial assets” (2011, Locations 452-454).

3 Founded in 1948.

4 When the savings-and-loan fiasco erupted in the US.

–  –  –

In fact, when in the summer of 2008, a small group of foreign “financial experts” headed to China to give financial advice, Wang Qishan, the vice-premier in charge of China’s financial sector, quickly made it clear that China had little to learn from the visitors about its financial system. His message concisely: “You have your way. We have our way. And our way is right!” (Mc Gregor: 2010, Kindle Locations 51-52).In the same vein, Chen Yuan, the celebrated chair of China’s Development Bank was clearly thinking along these lines when he declared, in July 2009, “[We] should not bring that American stuff and use it in China. Rather, we should develop around our own needs and build our own banking system” (Yuan quoted by Walter and Howie: 2012, 27).

They had a point. If we look at Chinese Banks’s capitalization and non-performing loans

at the height of the crisis (compared to JP Morgan), the data speak for themselves:

Table 1- Chinese Bank’s Capitalization Compared with J P Morgan (JPM) in 2010

–  –  –

200 186 163 150 136 126 100 66 60 39 50 24 0 Source: Walter and Howie, Location 1069 Table 2 – Non-Performing Loans of Top Chinese Banks: 1999-2010

–  –  –

3.500 40,00% 35,00% 3.000 30,00% 2.500 25,00%

–  –  –

20,00% 3.277 1.500 15,00% 2441 1.983 2155 2077 1.000 10,00% 1718 1313 1255 1268 500 5,00% 560 497 429 0 0,00% 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

–  –  –

Source: Walter and Howie, Location 1114 Notwithstanding, this institutional design was the result of a learning process and major reforms in the urban economy’s state sector finances. If we step back and reset to 1997, the reality we meet is that China had launched the enterprise finance and banking reforms it had put off because of the 1989 Tiananmen crisis. To outside observers, it might seem that the July 1997 Asian Financial Crisis (AFC) hit the Chinese banking system hard. However, beginning in the winter before the crisis broke out, China had already begun closing or selling off state enterprises and warehousing non-performing loans. The immediate results were an apparent decline in asset quality and a spike in their non-performing loans. By 1998, more than half of all the loans issued by the Industrial & Commercial Bank of China, the country’s biggest lender, were unrecoverable, and for the whole banking system, 45% of loans made before 2000 were declared bad (Cousin: 2011, p 9).

In essence, the party apparatus in Beijing, in tandem with its Central Organization Department, had seized the power to hire and fire senior executives in banks and other state enterprises no matter where they were in the country (McGregor: 2010, Location 1001). To most observers, the government’s regulatory system remained intact on the surface. The local banks and regional regulatory authorities were outwardly undisturbed. However, the Politburo had created a parallel policy toolkit, ‘a powerful yet mostly invisible party body for monitoring financial institutions and their executives’.

8 Keidel and Burlamaqui- MINDS Conference

These actions were bold and the results quickly showed up. Between 2000 and 2003 5, the government’s (more properly, its new regulatory compact) “moved”6 over US$ 400 billion away from the “Big 4” balance sheets in order to clean them (Walter and Howie: 2012: 5).



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