How does China finance its development projects in Africa and South America?
China Development Bank
It’s largely due to a financing strategy conceived and spearheaded by the China Development Bank (CDB), the policy bank that stands at the forefront of China’s state capitalism model.
In essence, this financing strategy facilitates the trade of what China has in abundance ...
Large-scale manufacturing capacity in certain infrastructure and capital-intensive industries such as telecom equipment, solar panels, high-speed railway and wind turbines.
Project management resources and labor that have significant relevant experience building and installing massive amounts of this stuff in China.
... for what they have relatively little of, namely ...
Crude oil and certain mineral resources to finance the continued build-out of modern China.
How does this happen? Let’s illustrate with a typical project:
A certain African country wants to upgrade its mobile network to LTE. It puts out an RFP to the usual players: Ericsson, Alcatel-Lucent, Nokia-Siemens as well as the two leading Chinese players: Huawei and ZTE. In this case, Huawei’s bid is the lowest price compared to everyone else and on top of that, it is fully financed by a consortium of Chinese banks and also comes with a turnkey contracting team that will install and run the network. It wins the bid. The other bids come in more expensive with longer implementation timetables and put more of the burden of raising the financing on the host country.
A few questions jump out:
How is Huawei able to offer the lowest price?
The answer varies industry by industry, but the general theme is that Chinese firms can offer competitive products at significantly lower prices. Their input costs (e.g. R&D engineers) relative to productivity are lower and increasingly, the Chinese firms are the ones with scale. In a number of higher value-add industries, China has gotten really good at building quality products that are globally competitive, particularly infrastructure-related goods. Examples include telecom equipment, wind turbines, solar panels, power equipment, large ships, transportation projects and high-speed rail. Some of these companies are state-owned but many of them are private sector that have proven themselves capable of competing at a high level on the global markets.
These companies got better over time by manufacturing products first for the large and relatively protected home market and more recently by exporting product overseas. And just like you get better by practicing, Chinese companies have increased their capabilities and quality by building lots and lots of products. China is quickly moving up the value chain.
Second, where does the money come from?
This is where the CDB steps in. They take the lead in assessing the overall deal, taking into account not only the usual risks that other banks would consider but also how the deal advances China’s policy goals. In this case, there are explicit development goals that want to encourage export of high-value goods such as telecom equipment as these create high-value jobs for China’s growing economy and helps Chinese companies become more competitive.
After the CDB signs off on the deal, it underwrites a certain amount, often a small percentage of the overall financing need. But with the CDB’s “Betty Crocker” seal of approval, other Chinese banks such as Bank of China and ICBC will step in to finance the rest of the deal.
Third, how can they offer financing to typically poor countries with shaky international credit?
This is the most interesting question. Certainly, part of the answer is subsidized credit to encourage and facilitate exports of these products. This is made possible by having lower cost of capital requirements than typical private banks. This is the same as other Export Credit Agencies (ECAs) such as the US Exim Bank or the nearly 60 other ECAs around the world.
But what the CDB does differently is how it structures and underwrites its loans.
First, it typically will structure the loans by securing them with physical oil or mineral deliveries. For example, if Venezuela can no longer find dollars to re-pay its loans, the CDB has the right to specific deliveries of oil. This reduces the default risk significantly, and as it is a state bank, the CDB can tap into better diplomatic channels to enforce loans than private financing sources. This is also why China tends to extend more loans (and thus greater trade) to mineral-rich countries - they do actually care about getting repaid in one form or another.
Second, the CDB will take into consideration the amount of China content in determining whether to offer financing. Typically, more than half of the value of the loan proceeds are paid directly to Chinese companies (e.g. Huawei), Chinese contractors (who provide expatriate labor to install the equipment) and other Chinese vendors. In essence, that money never even leaves China. The more China content the better from the CDB’s policy perspective. Typically, the traditional Western vendor does not offer as much of a turnkey solution, usually hiring locally and providing oversight. This is because seconding U.S. citizens is expensive compared to seconding Chinese workers and Chinese workers are more willing to take on the risks of travelling to risky places like Sudan. Often by having to hire local labor, projects are more difficult to manage and deliver on time.
If you are interested in learning more about the CDB and its important role in China’s development, I would highly recommend reading China’s Superbank: Debt, Oil and Influence
This was originally published on Quora in November 2014.