Calls for reform in China tend to come in two kinds – one, the most common in Chinese social media and popular discussion, calls for a crackdown on endemic forms of local tyranny, such as land seizures, black prisons, and bribery. The other, found among liberals within the Party and expatriate businessmen, talks about rolling back the growing dominance of the state and state-owned companies over the Chinese economy, opening more markets to competition and ending the practices that allow state-owned (or state-blessed) companies to command cheap access to capital, natural resources, and land.
So far, Xi Jinping's term looks promising for advocates of the first but the book China's Superbank: Debt, Oil and Influence – How China Development Bank is Rewriting the Rules of Finance makes a case that land seizures are at the very foundations of China's model of state capitalism. The new book by Bloomberg journalists Henry Sanderson and Mike Forsythe argues that the explosion of China’s state investment last decade has been powered by the financial engineering of a single institution, China Development Bank (CDB).
The key connection in their account is a financial structure that may one day become as notorious as “collateralized debt obligations” – the local government financing vehicle (LGFV). Invented by the CDB in the late 1990s to finance infrastructure development, they have become cash cows with an insatiable hunger for land.Enjoying this article? Click here to subscribe for full access. Just $5 a month.
LGFVs play a critical role in allowing local governments to make huge investments in large projects. Some, like China's highway system, play a crucial role in China's development. Others, like a full Olympic stadium park in the sixth-largest city in Hunan, serve mainly to boost local GDP figures.
Raising money for these projects is a challenge for local governments, which have little control of tax revenue and are not allowed to issue bonds. They can, however, set up semi-commercial companies which are eligible for bank loans – the LGFVs – thus tapping into both the CDB's ability to issue bonds at sovereign rates and the enormous deposits of Chinese favors. After being given formal ownership of city assets, the LGFVs can offer collateral for enormous loans (mostly, however made up of non-revenue-producing assets like roads and public parks), and by constant land sales they can cover the interest – especially as new parks, highways, and Olympic stadiums raise land values. Completing the circle, these new assets are transferred to the LGFV, giving them collateral for further loans.
Loans of this type composed much of the massive 2008 stimulus, driving local government debt up to an estimated 40 or 50 percent of China's GDP. They were made by all of China's major commercial banks as well as the CDB – meaning that their ability to repay depositors, as well as the CDB's ability to pay its evidently government-backed bonds, depends on high land values and continued revenue from land sales. With the stability of China's entire financial system at stake, an effective crackdown on land seizures may be a long time coming.
Sanderson and Forsythe identify the CDB's long-serving chief, princeling Chen Yuan, as the driving force behind the wave of massive bank loans. Over the course of the past ten years, they write, his model of colossal lending on tenuous security has been rolled out on a massive scale – applied to everything from funding megaprojects like the Three Gorges Dam, to financing the development policies of African and Latin American oil producers, and bankrolling new industries like solar which are locked in price wars with overseas competitors, frequently placing Chen at the center of China's industrial and foreign policy. He has found ways to use lending in support of policies ranging from oil acquisitions overseas to the expansion of the National Champions, shaping these policies to meet his vision of state capitalism.
If Xi wants to roll back the state's role in the economy he will face stiff resistance. Under the Hu administration, the bank resisted years of reform efforts by the State Council – even after Prime Minister Wen Jiabao announced that it was to be stripped of its special status and made into an ordinary commercial bank, the CDB continued to issue bonds on the credit of the Chinese government and eventually forced Wen to retract. But Chen Yuan is already 68, and with the princeling generation at the end of its tenure, his influence may be somewhat reduced – especially in confrontation with another princeling. On the other hand, Chen may have built an office whose powers will outlast its occupant – with many of China's biggest cities, companies, and foreign policy initiatives reliant on CDB financing, it will be very hard indeed to mobilize the Communist Party against its bankers.