Battling a slowdown in the local economy and a glut of debt, China’s corporations are being forced to look elsewhere for profit, and many of them are turning to importing in-demand commodities. Mark Godfrey reports.


Hurting from a slowing economy, Chinese firms are diversifying into non-core areas in a bid for better margins. Sourcing of agricultural commodities overseas has become a new source of profit. A recent US$5mn deal, whereby a Chinese state-controlled exporter of chemicals products turned importer of soybeans, illustrates the point.

A source at the Beijing-based state-owned oil and chemicals distribution firm details how company executives used a circuitous route to get the soybeans from Brazil. Since agriculture wasn’t the company’s core area of business it wasn’t possible to get approval from the National Development and Reform Commission (NDRC), a state policy implementation body. An attempt to use the Bank of China was thwarted by head office when the bank declined to issue a letter of credit.

The firm eventually used a Hong Kong-based subsidiary to open the letter of credit through China Construction Bank. With the shipment currently on the seas, the soybean deal has proven a rocky one, in large part due to the lack of experience in soy: the executive feels the firm overpaid. “We had never dealt in the soybean trade before but we saw the opportunity, it’s a risk but if it works out it’ll be a very profitable risk,” said the executive who spoke on condition of anonymity.

Many of China’s industrial firms are turning to trading to alleviate bad financial conditions at home: many state-owned heavy industry companies are seeking new sources of revenue because they are in “very bad shape” due to overcapacity and debt, says Andy Rothman, long-time chief China economist at CLSA and now at Matthews Asia. He’s predicting “a lot more volatility” in coming months as Chinese regulators increase their focus on local banks’ mounting debts.

Rothman also predicts a wave of corporate defaults as China seeks to enforce market-driven rules in corporate finance.

China is seeking to reduce its reliance on credit-driven growth. Total social financing, an indicator of overall credit in the system, exploded since 2009, from Rmb7tn in 2007 to Rmb17.3tn in 2013. “That’s not sustainable,” says Shen Minggao, head of research at Citibank in mainland China. He believes the current squeeze in credit being engineered by government is leading indebted firms to resort to speculative trade deals as well as the use of letters of credit to get credit.

Aside from being the world’s top exporter (US$2.2tn worth of goods shipped in 2013) China is also emerging as the planet’s leading importer: the figure for 2013, US$1.95tn, represents a 93.9% increase on 2009. Soybeans may become a target for more Chinese firms seeking a profitable trade: growth in imports of China’s agricultural raw materials is outstripping growth in imports of energy and cars. Imports of meat rose 248% year-on-year in 2013 to US$5.9bn while dairy imports were up 401% to US$5.2bn and cereals imports were up 477% to US$5.1bn. Imports of oil meanwhile rose 153% to US$314bn and inward shipments of vehicles rose 161% to US$74bn.

Seeking speculative resource deals will become the norm for China’s state-owned firms, which account for 92% of China’s overseas investment (and get three quarters of corporate loans in China) largely in resource-extraction projects. A target for Chinese iron ore mining, Brazil, saw its exports to China in 2013 hit US$53.7bn: of that US$19.1bn was spent on oil seeds, primarily soybeans – oil made up another US$3.8bn, sugar US$1.4bn and wood pulp US$1.9bn. China also bought half a billion dollars each of steel, meat and animal fats.

Banks: adapt to survive

Suffering from a tightening of liquidity and an overhang of bad debts, China’s banks meanwhile are actually more open to low-risk activities such as trade finance. Chinese-listed banks saw their non-performing loans (NPLs) rise 7.8% quarter-on-quarter in the first quarter of 2014 and now stand at a hefty Rmb518bn. This means the People’s Bank of China (China’s central bank) will have to let the bad loans go sour – an increasing likelihood.

“Trade finance has always been an attractive business for China’s big banks, like Bank of China, because they tend to be very familiar with the Chinese customers who are usually state-owned companies. Traditionally there hasn’t been much risk involved,” says a source at the China Banking Regulatory Commission, which regulates Chinese banks.

The larger Chinese banks that were very open to risk taking before the June 2013 liquidity squeeze now have to scale back to non-risky lending. Smaller banks meanwhile are increasingly opting for higher-risk, higher-yield business: Ping An Bank reported a 40% year-on-year rise in profits in the first quarter while Bank of China reported a 12% rise year-on-year. ICBC and Bank of Communications meanwhile both reported below 10% profit growth and China Construction Bank was on 10%.

The bad debt situation looks ominous for Bank of China, which saw NPLs rise by Rmb7bn in the first quarter, equal to 90% of its entire 2013 figure. The figure at the Bank of Agriculture doubled year-on-year to Rmb4.2bn in the first quarter.

Banks operate at a time of flux and uncertainty. China is set for a string of corporate defaults and a continued lowering of real estate yields triggering defaults by developers, explains Ning Zhu, professor of finance at Shanghai Jiao Tong University. Central government revenues are rising 12% while expenditure is rising 20%, even as export growth slows. “Trade went from 40% of GDP to current single digits… that’s scary.”

He’s predicting an exodus of Chinese capital chasing deals overseas: “It’s a no-brainer, local equities [on the Shanghai exchange] return an average 4% a year compared to the international equities with a return of 12% in 2013.You can get 1.5% rent yield on an apartment in Beijing or 67% on a house in California, so Chinese cash is exiting overseas.”

Meanwhile China’s economy will continue to slow: in the absence of financial reforms we’re looking at 5.5% GDP growth in 2020, says Shen Minggao, head of China research at Citi. The reforms he and other economists want to see include interest rate liberalisation and reform of local government financing to a more sustainable model based on US-style municipal bonds rather than short-term borrowing as is currently the case.

Evolving into the future

There is a long-term reason for optimism: the ongoing urbanisation grand plan which is supposed to, theoretically at least, shift farmers on Rmb492 per month into cities where tier one cities like Beijing boast an average monthly income of Rmb2,240. This in turn will fuel a consumption boom and further drive imports of proteins and consumer goods.

At the same time, China has been seeking to turn economic advantage into strategic advantage, using banks and trade as tools to further government foreign policy goals. ICBC’s withdrawal of finance for an Iran-Pakistan gas pipeline in 2012 was a shot across the bows but policy watchers in Beijing see a manipulation of banks by top government officials for policy goals abroad.

Local media has reported how over US$30mn has been lost by banks financing trade and investments by Chinese companies in North Korea. “We’re dealing with a real moral hazard problem here: local companies poured into the border countries when there’s an implicit guarantee their losses will be covered or written off by their state-owned banks,” explains James Reilly, a researcher at the Australia-based Lowy Institute focusing on Chinese trade with neighbouring states.

Likewise, says Reilly, China has been front-loading trade deals with strategic partners: it’s keenness to get Taiwan support means trading companies in the province of Fujian have been given carte blanche to get trade finance.
“It’s a strategic goal of national government.”

China’s top foreign currency lender, the CDB lends more in Asia than the ADB and World Bank put together. An Asia Infrastructure Bank is planned by the current government of Xi Jinping: his predecessors extended a US$15bn credit line to poorer Asean states to tide them over the financial crisis.

Looking to the future, China has set itself some very ambitious targets: increasing trade with Russia from a current US$90bn to US$200bn by 2020 (helped by a gas deal) while it’s seeking to double trade with another major gas supplier, Kazakhstan, to US$40bn by 2018. Meanwhile it has pledged to reduce its trade surplus with developing nations: the Ministry of Commerce recently pledged to try to “import as much as possible” from Morocco, which has protested the heavy trade deficit it’s run up with China, which supplies the country with consumer goods as well as machinery and ships.