“1. Capitalizing Development: From Tax Revenue to Bonds” in “The Latecomer’s Rise”
1 CAPITALIZING DEVELOPMENT
From Tax Revenue to Bonds
China has become a leading global development finance provider in the twenty-first century. According to AidData, the total amount of official development finance the country committed between 2000 and 2017 was $843 billion.1 According to the Global Development Policy Center, Chinese overseas development finance amounted to $462 billion between 2008 and 2019, rivaling the World Bank’s $467 billion.2 Since the launch of the Belt and Road Initiative (BRI) in 2013, China has announced that it would offer huge magnitudes of capital support for developing countries. For instance, it announced the investment of $124 billion for BRI at the first BRI Summit in 2017.3 It pledged $60 billion in 2015 and the same amount in 2018 to Africa’s development at the Forum on China-Africa Cooperation.4 In addition, China pledged $250 billion to Latin America and the Caribbean at the first ministerial meeting of the Forum of China and the Community of Latin American and Caribbean States.5
These numbers raise the question as to where China gets all this money. Given that the announcements were made by the Chinese government and the pledges were directed at developing countries, it is natural to assume that China’s fiscal revenue funds all of the “aid” along the Belt and Road. Indeed, the world’s largest economies routinely transfer government funds to less-developed economies in the form of bilateral development assistance. However, the Chinese case is somewhat different. Statistics from China’s Ministry of Finance show that government expenditure on foreign assistance (duiwai yuanzhu) was ¥15–20 billion renminbi per year, or about $2–3 billion in U.S. dollars, between 2010 and 2019.6 Secondary research estimates that the net disbursement of China’s foreign aid, including bilateral aid, government concessional loans, and contributions to international organizations, was $3–7 billion per year in that 2010–2019 period, an amount that was only half of the official development assistance disbursed by major traditional donors such as the United States, the United Kingdom, Germany, and Japan.7 The limited amount of government spending indicates that contrary to conventional wisdom, taxpayers are not covering the majority of China’s overseas development finance.
The question arises, then: How does China capitalize development finance around the world? A quick answer is that the vast majority of Chinese credits have been funded by China’s two policy banks rather than government departments. According to official data, the China Development Bank (CDB) and the Export-Import Bank of China (China Exim) had each disbursed tens of billions of overseas loans yearly between 2004 and 2014, which was much larger than the government’s foreign assistance (figure 1.1).8 Data from the Global Development Policy Center estimated similar size of policy-bank loans between 2008 and 2018.9 The majority of policy-bank lending does not come from budgetary appropriation but rather from selling long-term, state-guaranteed bonds on the market. The policy banks’ annual reports indicate that bonds issued have usually accounted for more than two-thirds of their total liabilities (figure 1.2).
This chapter addresses questions about the policy banks’ role in capitalizing China’s development finance: How have they become major creditors of China’s development projects while government organs have not? Why do the banks raise funds primarily through bond issuance? What does this choice indicate about China’s development financing? To answer these questions, this chapter focuses on the fundraising mechanism of the CDB, which is China’s largest policy bank and the world’s largest development bank by total assets. By illustrating how the CDB has facilitated the creation of an interbank bond market to capitalize China’s domestic development, the chapter paves the way to understanding the rationales underlying China’s overseas development finance.
Counterintuitively, as the chapter demonstrates, far from relying on government revenue to finance its development activities, China has made a continuous effort to move away from a centrally planned system in which the state determines credit allocation. To capitalize industrial and urban development, the state has built and empowered market institutions, transformed government organs into market players, and adopted financial instruments from overseas. Yet this process—the financialization of the state—does not imply a declining role of the state; rather, it has been largely reliant on the state’s support and has contributed to the strengthening of state capacity in facilitating development.
FIGURE 1.1. China’s overseas development finance capital by different providers (in USD billion). Sources: Adapted from Almanac of China’s Finance and Banking, various years; China Development Bank Annual Report 2014; Naohiro Kitano and Yumiko Miyabayashi, “Estimating China’s Foreign Aid: 2019–2020 Preliminary Figures,” JICA Ogata Sadako Research Institute for Peace and Development, 2020.
Note: The two policy banks do not publish their volumes of overseas loan disbursements annually. Policy-bank data in this figure documents the two banks’ annual “foreign-currency loan disbursement” (Almanac of China’s Finance and Banking). This data is an underestimation of a bank’s total overseas lending because loans denominated in renminbi may also be used for financing overseas projects. The almanac does not report China Exim’s foreign-currency loan disbursement in 2009 or after 2014 or the CDB’s foreign-currency loan disbursement after 2013. The CDB’s 2014 disbursement ($100 billion) is an underestimation because the bank’s annual report that year stated that it disbursed “more than $100 billion foreign-currency loans in that year” (CDB Annual Report 2014, 11). Government foreign aid is extracted from Kitano and Miyabayashi 2020. The numbers are an overestimation of government funding because they include government concessional loans, which are primarily financed by China Exim and only minimally subsidized by the government.
FIGURE 1.2. Structures of liabilities of the two policy banks (December 31, 2020). Sources: Adapted from Export-Import Bank of China Annual Report 2020; China Development Bank Annual Report 2020.
Emergence of China’s Banking System: From Government Organs to Financial Agencies
The creation of policy banks can be perceived as part of an overarching institutional reform of China’s financial system. By the late 1970s, markets barely existed in China. The state controlled almost all forms of credit allocation. The evolution of China’s financial institutions in the Reform and Opening Up era began in 1978 has therefore been a process of financialization departing from status “zero”—a centrally planned economy. Before 1978, China had a Soviet-style, unitary credit allocation system. The People’s Bank of China (PBOC), China’s central bank, was the only bank in China, and it was a part of the Ministry of Finance (MOF). MOF made budget plans, and the PBOC spent the money. In other words, there was no clear distinction between a fiscal system and a banking system. Nor was there a distinction between central banking and regular banking, as the PBOC was the bank that apportioned credits to finance all forms of economic activities.
As the Reform and Opening Up proceeded under the leadership of Deng Xiaoping, a round of financialization began—multiple financial agencies were established to assume varied financial responsibilities. The PBOC left MOF and became an independent central bank in 1978. In the next year, the Agricultural Bank of China was established to manage loans to the agricultural sector and coordinate rural credit cooperatives, Bank of China was separated from the PBOC to manage foreign-currency loans, and the China Construction Bank gained independence from MOF as the entity handling infrastructure and construction loans. In 1984, the Industrial and Commercial Bank of China was founded to assume corporate lending from the PBOC.10
The creation or revitalization of the financial agencies from 1978 to 1984 demonstrates a first step of crafting a financial market. Fiscal allocation, central banking, and regular banking were formally separated from one another, and the government organs that used to be “cashiers” of fiscal revenue were turned into banks. The four newly (re-)established state-owned specialized banks—the Agricultural Bank of China, Bank of China, China Construction Bank, and Industrial and Commercial Bank of China—also dubbed the Big Four (si da hang), constituted the earliest and major players of the nascent financial market. Today, the Big Four are still China’s largest state-owned banks and have become the world’s largest banks.11
Transitioning from government organs, the four specialized banks struggled to become real banks. Their business scope covered both commercially viable projects that generated profits and policy-oriented projects that typically did not. It was therefore rather challenging for them to focus on pursuing profitability exclusively. To a large extent, they acted like alternative channels of fiscal spending. A result of their ambiguous policy/business mandates was the emergence of large volumes of nonperforming loans. In the early 1990s, policy discussions emerged with regard to how these banks should separate policy-serving finance and commercially oriented finance, and the result was the birth of three policy banks. In 1994, the CDB, the China Exim, and the Agricultural Development Bank of China were officially founded, assuming policy-oriented projects in infrastructure and industrial financing from the China Construction Bank, export and trade financing from Bank of China, and agricultural financing from the Agricultural Bank of China, respectively. This would allow the Big Four to focus on profit-generating projects solely. Since then, the specialized banks were identified as state-owned commercial banks (shangye yinhang) in official documents. In other words, the birth of the policy banks was a part of China’s market-oriented bank reforms and continuous financialization.
A major challenge facing the newly established policy banks was how to raise funds for policy-serving but commercially nonviable projects that they were mandated to finance. An easy way to do so was to request a government subsidy, but that would mean a return to central planning practice, which was in contradiction with the government’s original aim in establishing these banks. Zhu Rongji, then vice prime minister and central-bank governor, laid out the objectives of the creation of the policy banks in the National Finance Work Conference in 1993, implying a separation of the banks from the government’s fiscal safeguard: to “alter the current banking system” such that it would “distinguish policy from business obligations” and so that policy banks should be “self-managed, financially balanced, and responsible for their own risks.”12 Instead of channeling fiscal revenue to subsidize policy-serving projects, China’s policymakers designed an alternative means of fundraising for the three banks: issuing state-guaranteed bonds to other financial agencies. But at that time, China did not even have a market for bond transactions. In their first four years, policy banks’ “bond issuance” was more like the state’s credit allocation with a facade of bond issuance: policy-bank bonds were apportioned by the central bank to designated purchasers. As the sections below will show in greater detail, it took the CDB a few years to build a real bond market from which it could raise sufficient funds for policy-oriented lending.
The Funding Mechanism of Policy Banks: A Hybrid Practice
Fundraising challenges have not been peculiar to Chinese policy banks. In many countries, fundraising has been an issue for public financial agencies (PFAs), including aid agencies, national development banks, and export credit agencies. On the one hand, PFAs must capitalize large-scale, long-term projects that are not always profitable, and therefore they need to have access to low-cost funding such as government revenue in order to break even. On the other hand, PFAs are financial agencies. Receiving cheap capital from the state would disincentivize them to practice prudent financing and give them an unfair advantage over commercial banks. To reconcile state and market incentives, PFAs usually raise funds through a combination of methods, incorporating various channels such as borrowings from government funds, bond issuance on the market, and deposits by clients.13
At the meantime, Chinese policy banks employ a hybrid funding mechanism, which integrates characteristics of market-based bond issuance and savings-based, state-coordinated finance. To understand how this mechanism works and how it came into being in the late 1990s, it is necessary to first examine the two prototypical funding mechanisms that the CDB—the policy bank that led major institutional changes in China’s bond market—intentionally modeled itself on: Japan’s state-coordinated Fiscal Investment and Loan Program (FILP) and a bond-based funding mechanism practiced by the Credit Institute for Reconstruction (KfW, Kreditanstalt für Wiederaufbau) of Germany, the largest national development bank in Europe.
Coordinated by Japan’s Ministry of Finance and known as the country’s “second budget,” FILP is a financial system channeling postal savings and pension reserves to PFAs mandated to serve policy-oriented goals (figure 1.3). Some of the largest of these agencies are the Development Bank of Japan, Japan International Cooperation Agency, and Japan Bank for International Cooperation. Throughout the postwar era, FILP has provided long-term, low-interest-rate credits to projects that align with Japan’s policy objectives, contributing to the country’s industrial and economic development.14 The Japanese public-funding mechanism had two important features that distinguish it from the German one (discussed below). The first was that the origin of capital was primarily domestic savings. The second was that the state played a crucial role in determining the amount, cost, and destination of the capital flow.15
Germany also has PFAs that lie in between the state and the market—namely, promotional banks (förderbanken), the largest one being the KfW. The development bank raises most of its funds through bond issuance (figure 1.4). These bonds are implicitly guaranteed by Germany’s federal government in that they are not calculated as government debts but backed up by sovereign credibility. This guarantee is stated in the KfW Law.16 As a result of such state support, KfW bonds are rated as highly as Germany’s government bonds by credit-rating agencies, which ensures their attractiveness to international investors. The currency portfolio of KfW bonds is quite diverse, including euros, U.S. dollars (USD), Australian dollars, and Japanese yen, among others. In 2020, the KfW issued bonds in 14 currencies, primarily in euros and USD.17 This shows that the creditworthiness of KfW bonds is acknowledged globally. Compared to FILP, the KfW’s funding mechanism is more market-based, because the price and volume of funds raised are primarily determined by the supply and demand of the international bond market, and the German federal government offers sovereign guarantee only.
FIGURE 1.3. The Japanese practice
FIGURE 1.4. The German practice
Compared to the Development Bank of Japan or the KfW, which had been engaging in industrial and development finance since the 1950s, the CDB was a relatively young PFA and barely had any experience in development banking when it was established in the 1990s. Policymakers in China had to look around at the world’s leading national development banks to find fundraising mechanisms suited to China’s own needs, and eventually they adopted one that integrated both the Japanese and the German practices.18 In a nutshell, the hybrid Chinese practice has two parts: to issue bonds on the market and to use state guarantees to attract investors, mainly domestic financial agencies (figure 1.5). A main factor contributing to CDB bonds’ popularity is that like KfW bonds, they are supported by the state’s sovereign guarantee. China’s National Administration of Financial Regulation (formerly the China Banking Regulatory Commission) assigns CDB bonds “zero-risk weighting.”19 This means that the investors bear minimal risk for holding CDB bonds. They do not have to set capital against CDB bonds because they are as safe as China’s government bonds.20 International credit-rating agencies such as Moody’s and Standard & Poor’s acknowledge them as such. The CDB also raises funds through government borrowings and clients’ deposits, but these play a relatively small role compared to bond issuance (figure 1.2).
However, unlike KfW bonds, which are sold mostly to international investors, CDB bonds are issued primarily onshore to domestic investors, especially China’s commercial banks, whose main sources of funding are corporate and household savings. According to official statistics, between 2015 and 2019, commercial banks held roughly 60–70 percent of policy-bank bonds; domestic investors such as credit cooperatives, insurance companies, securities companies, and others held most of the rest. Overseas investors’ holding of policy-bank bonds comprised no more than 3 percent.21 The onshore bonds that the CDB issued included both bonds denominated in renminbi and those denominated in foreign currencies. Between 2003 and 2015, the bank issued only $12.4 billion in onshore foreign-currency bonds on the domestic market.22 In other words, although the CDB raises funds in various currencies through market-based bond issuance, much as the KfW does, the de facto capital flow resembles FILP, taking place mainly in a domestic context.
FIGURE 1.5. The Chinese practice
This is not to say that the CDB does not issue bonds on the international market. The bank made its first samurai-bond issuance in 1996 (30 billion yen), first Yankee-bond issuance in 1997 (0.33 billion USD), first dollar-bond issuance in 1999 (0.5 billion USD), and first eurobond issuance in 2004 (0.325 billion euro).23 Yet the volume of CDB bonds issued outside China has been rather limited. Between 2005 and 2014, the bank did not issue any bonds overseas. In 2015, the CDB revived its global bond issuance, and by October 2020, it had issued a total volume of $21 billion on the international bond market.24 This implies an average annual issuance of $3–4 billion. This number is rather small compared with the ¥1–2 trillion domestic bonds (roughly equaling $170–360 billion) the bank issued yearly on China’s interbank bond market in the same time period.25 It is also much smaller than the amount of foreign-currency loans the bank disbursed overseas: in 2015, the CDB disbursed $127.4 billion on-balance sheet foreign-currency loans.26 In 2016, the CDB disbursed $12.6 billion loans to support countries along the Belt and Road.27 In other words, the funds the CDB raised from the international bond market could hardly cover the magnitude of overseas loan disbursements.28
Creating a Market for Public Finance
How and why has the CDB created a hybrid fundraising mechanism grounded in the bond-based, market-oriented German practice and the savings-based, state-coordinated Japanese practice? This section focuses on understanding both the structural factors and the agency factors that drove the CDB’s funding reforms. The bank was founded at a time when China had a large fiscal shortage and the central government’s revenue could not cover the financing of infrastructure and industrial projects. Nor did China have a developed capital market where the CDB could raise funds back in the 1990s. This structural background produced two diverging views of the role of the state in development finance. Liberal policymakers believed that government coordination was inefficient, and they intended to employ market tools to the maximum extent to finance public projects. Conservatives, on the other hand, highlighted the “policy-oriented” nature of the CDB, hoping to safeguard its source of capital through the state’s coordination of credits. The CDB’s current funding mechanism, therefore, was a result of the battle between these two driving forces.
CDB history since its founding in 1994 can be divided into three phases in terms of the evolution of its funding mechanism. The first phase (1994–1998) was the most state-controlled. The central bank coordinated the CDB’s fundraising mechanism in this period. In the second phase (1998–2008), the CDB gained relative autonomy. Policymakers institutionalized an auction-based bond-issuance mechanism and reduced the level of state participation in the CDB’s fundraising process. By the end of this phase, the state had almost completely withdrawn its involvement in the CDB’s fundraising, and it made plans to end its credit guarantee for CDB bonds. After the global financial crisis (2008-present), the policy-oriented aspect of the CDB was revalued, and the state’s credit guarantee for the bank was maintained and formalized after several years of debate.
1994–1998: Apportioning Bonds
In the first phase, the state’s involvement in the CDB’s fundraising process was the greatest. The funding mechanism of the CDB and the other two policy banks was coordinated by the central bank through administratively apportioned bond issuance (xingzheng paigou fazhai). That is, the PBOC required that domestic financial agencies such as commercial banks, urban credit cooperatives, and the Postal Savings and Remittance Bureau buy policy-bank bonds. Each buyer was assigned a quota and was required to buy their amount at a given price. That is to say, the central bank determined the volume, yield, and purchasers of these bonds.
In 1994, the CDB apportioned ¥65 billion bonds: ¥45.5 billion three-year bonds with a yield of 12.5 percent and ¥19.5 billion five-year bonds with a yield of 14 percent. From 1994 to 1998, the CDB issued ¥494.2 billion bonds. Among these, 56.23 percent were apportioned to the Postal Savings bureau, and 40.46 percent were apportioned to commercial banks.29 These numbers show that in the first four years, the CDB’s fundraising mechanism resembled that of its Japanese counterpart to a large extent. Both drew capital from savings, and both were coordinated by a state organ. The difference was that in Japan, the coordinator was the Ministry of Finance, and savings were channeled directly to an account that the ministry regulated, whereas in China the central bank channeled credits through apportionment.
A major problem with the state-coordinated administrative apportionment was that the yield of CDB bonds did not respond to the supply and demand of the bond traders. The yield set by the PBOC was usually high, which caused significant financial burden for the CDB. Moreover, the apportioned bonds could not be resold on a secondary bond market, which decreased the liquidity of assets of bond investors. As a result, financial agencies were reluctant to purchase CDB bonds. “In the first few years after the establishment of the CDB, we had to visit the central bank and negotiate with the investors every time before we issue bonds. It was hard,” said a source from the CDB.30
The CDB raised funds through administrative apportionment of bonds because there were no other options. According to the CDB’s official history, China’s policymakers did a great deal of research on foreign PFAs, including those in Japan and Germany.31 However, among the sources that PFAs typically relied on—fiscal revenue, postal savings, and bond market—all were short of funds in the early 1990s.
The central government was facing a fiscal shortage because, throughout the 1980s, a major portion of fiscal revenue was allowed to stay at a local level for the purpose of incentivizing local economic growth. As chapter 2 will describe, the CDB was founded in the early 1990s to enhance the state’s capacity in public financing and to address the state’s inefficient use of limited fiscal revenue. The fiscal shortage was so large that the central government had to revive the government-bond market, which was shut down from 1958 to 1980, in order to assist MOF in raising capital for public expenditure. However, the newly reborn bond market was not sufficiently developed in the 1990s to provide the financial infrastructure needed to support bond issuance without the state’s administrative apportionment. In fact, as will be discussed in detail below, it was the CDB rather than MOF that institutionalized an auction-based bond-issuing mechanism in China’s bond market.
The Postal Savings and Remittance Bureau was established to mobilize domestic savings no earlier than 1986.32 Thus, postal savings were insufficient to sustain the funding of the policy banks in the 1990s. In 1994, the total deposits at the Postal Savings were only ¥99.4 billion, while the CDB alone issued ¥75.8 billion bonds.33 The PBOC hence had to mobilize commercial banks to purchase policy-bank bonds in spite of their reluctance. The central bank’s administratively apportioned bond issuance, therefore, was an ad hoc method that allowed the policy banks to raise funds in their early years, when neither the state nor the market was able to provide sufficient capital for them.
Nevertheless, CDB bank officials recognized the need to explore diverse fundraising channels for the future. Thus, the bank made attempts to become a qualified bond issuer. It applied to a few major international credit rating agencies and received as high a rating as China’s sovereign bonds: Moody’s in 1994 rated it A3, and Nippon Investor Service and Standard & Poor’s in 1995 rated it AA- and BBB, respectively. On 29 February 1996, the CDB launched its first-ever overseas bond issuance in Tokyo and issued 30 billion yen of samurai bonds, with ten-year maturity and 4 percent yield. A year later, it issued $330 million Yankee bonds in the United States, with ten-year maturity and 7.413 percent yield.34 The issuance served as preparatory steps for diversifying the CDB’s capital source and allowed the bank to support China’s infrastructure equipment imports from overseas. Yet, compared to the CDB’s domestic issuance (¥118 billion in 1998), its overseas issuance was rather limited in volume.35
1998–2008: Playing the “Real” Market Game
The decade after the Asian financial crisis was critical for China and the CDB, since the crisis alerted Chinese policymakers to the importance of building a well-regulated financial market.36 China began to adopt international banking standards and further develop its banking sector. In April 1998, Chen Yuan, a former deputy governor of the PBOC, was appointed the new governor of the CDB. Chen Yuan is the son of Chen Yun, one of the most influential architects of China’s economic policy whose prestige since 1978 has been second only to Deng Xiaoping’s.37 Leveraging his incomparable political capital, Chen Yuan initiated a series of institutional restructurings to transform the CDB from a sheer credit allocator of the state into a “real” bank, aiming to reduce the level of state involvement in both the CDB’s capital-input and capital-output sides and allowing the bank to have more autonomy in making both its funding and lending decisions.38
Many raised concerns about the new CDB administration’s idea of withdrawing state support for the policy bank’s fundraising mechanism. MOF, the government organ responsible for public finance, was concerned that the cost for issuing bonds through market auctions might be even higher than through the government’s administrative apportionment, which might cause the volume of CDB funding to shrink and exacerbate the capital shortage for infrastructure and industrial financing. Doubts also arose from within the CDB. Some bank officials worried that the asset quality of the bank was not good enough to attract investors.39 Administratively apportioned bonds, after all, were a safe funding source for a bank mandated to finance infrastructure and strategic industries. Yet the concerns and oppositions from conservative policymakers did not stop Chen from restructuring the bank. As Chen wrote later in his memoir, “These concerns all make sense … but as a bank, we must follow market rules and banking regulations. Marketization is inevitable.”40
On 2 September 1998, the CDB launched its first “marketized” (shichanghua) bond issuance. Being marketized meant that the central bank no longer determined the bonds’ yields or designated the financial agencies to purchase them. A market-based auction replaced state-coordinated apportionment between the CDB and many financial agencies. During the auction, bidders offered their favorable level of volume and yield of bonds, and those who offered the lowest yield won the bonds. The auction succeeded because bidding results showed that only some of the bidders won the bonds.
In 1999, the CDB moved a step further and created China’s first floating-rate bond. Before that, yields of CDB bonds were all fixed, which could pose a risk for bond investors, especially commercial banks. This was because the cost of funding for commercial banks was primarily determined by the interest rate of deposits, which might fluctuate during the years of holding CDB bonds. A floating-rate bond with yield moving around a certain benchmark rate would be more ideal for those investors. Nonetheless, at that time there was no widely acknowledged benchmark that could be considered a reference for the floating rate of CDB bonds. The CDB therefore went ahead and set up the first-ever benchmark of floating-rate bond on China’s bond market, which was the PBOC’s one-year deposit rate. This financial innovation lowered the risks for holding CDB bonds and therefore increased their attractiveness to investors.
The CDB was a pioneer in practicing market-based bond auctions and creating China’s first floating-rate bond. Perhaps even more importantly, it was a founding issuer in China’s interbank bond market. Before the CDB’s innovative bond-issuing practices, government bonds issued by MOF through administratively apportioned underwriting dominated China’s bond market. Designated investors were reluctant to purchase government bonds, much as they were with apportioned CDB bonds. Some MOF officials made attempts to marketize the issuance of government bond, but in the early 1990s, most people believed that “apportionment” was a sufficient fundraising method and there was no need to change. “Through their lens, this kind of view made sense, because they had never seen what a market looked like,” recalled Gao Jian, then deputy director of MOF’s Department of Government Debt Administration and a reformer who advocated the marketization of government bond issuance.41 “We must transit to a new mechanism—auction,” Gao said in 1993.42 The MOF held China’s first bond auction in 1996 and issued three-year, seven-year, and ten-year government bonds, but this market-based practice did not continue.43 Two years later, the transition from apportionment to auction occurred on the newly established interbank bond market.44 The auction was led by the CDB, where Gao was invited by Chen to serve as the CDB’s chief economist and director of the Treasury Department in October 1998. Since then, auction-based bond issuance became an institutionalized practice for the CDB, and others soon followed. MOF and China Exim adopted a bond auction in 1999, and the Agricultural Development Bank of China followed up in 2004.45 The CDB’s leadership in developing China’s interbank bond market has resulted in the bank’s prominent position on the market. To date, when financial agencies and corporations issue bonds, CDB bonds are still considered an important benchmark.
The CDB’s auction-based fundraising mechanism was not completely free of state participation. Although the PBOC withdrew from the role of determining the yield and the amount of CDB bond issues, it still had the authority to decide the list of bidders who could join the auctions to purchase CDB bonds. Moreover, in the first few years after its first marketized bond issuance, the CDB was partially supplemented by capital raised through administrative apportionment, mostly from the postal savings. This was a favor given by the PBOC to assist in the bank’s transition from administrative apportionment to market-based bond issuance. Yet it was not clear whether the CDB could still attract bond investors from the market without the PBOC’s support. In other words, it was not clear if the CDB’s own creditworthiness on the bond market was sufficiently high to compensate fully for the effect of state coordination.
In 2004, the state’s credit guarantee for CDB bonds was formalized, replacing the PBOC’s administrative apportionment as a new means of state support. The China Banking Regulatory Commission (CBRC)—now known as the National Administration of Financial Regulation—issued an official document, Regulations for Capital Adequacy of Commercial Banks, which stated that commercial banks hold zero-risk weighting when holding policy-bank bonds.46 The state-authorized regulation incentivized commercial banks to buy policy-bank bonds as safe long-term assets, thereby ensuring the policy banks’ funding sources. It is important to note that the concept of “risk weighting” was adopted from overseas—Basel II, a set of international banking regulations put forth by the Basel Committee on Bank Supervision, was published in June 2004, and in the same year the term was formally used in official documents in China. The concept was localized to enhance the creditworthiness of policy-bank bonds.
Throughout the decade after the Asian financial crisis, the CDB adopted many other international practices to improve its appraising, lending, and auditing processes, turning into a bank functioning on market standards and building its own credibility in accordance with international banking standards.47 The financial restructurings also increased the CDB’s political power in that it was able to challenge government ministries that used to coordinate industrial and infrastructure finance and turn down projects that did not meet its banking standards. In other words, with its own rules, the CDB gained the authority to say no to China’s central government organs.
The CDB’s market-oriented reforms reached a peak on the eve of the global financial crisis, when the Chinese government decided to turn the CDB into a commercial bank, despite the policy bank’s reluctance to lose its state-granted privileges.48 In 2007, then prime minister Wen Jiabao announced in the National Conference on Financial Work that the CDB should “fully practice commercial banking, become self-managed, and be responsible for its own risks as well as profits and losses.”49 This decision was, on the one hand, a result of the CDB’s rapid financialization—as the bank become more market-oriented, its mandates, responsibilities, and regulatory requirements needed to be redefined. On the other hand, the CDB had become too powerful under Chen’s leadership. Its involvement in a wide range of financial activities with the sovereign guarantee not only challenged traditionally powerful government ministries, but it also irritated commercial banks that had to compete with the CDB for business without receiving the state’s credit support provided to the policy bank.50 Transforming the CDB into a regular commercial bank would deprive it of some privileges and level the playing field.
2008–Present: Returning to Policy Banking?
Nonetheless, the state’s attempt to entirely withdraw its credit support for the CDB caused turbulences on the interbank bond market. When the CDB held bond auctions in 2007, demand for CDB bonds dropped dramatically because investors were concerned that the bonds would lose zero-risk weighting when the CDB became a regular commercial bank. The failed auction consequently led to question for policy debate—whether the CDB could still raise a sufficient amount of capital to support long-term public projects if it were to lose the state’s sovereign guarantee.
Chen Yuan firmly believed that CDB had to retain the sovereign guarantee for its bond issuance. Over the course of 2007–2008, Chen and his team of bank officials visited MOF, the CBRC, and the PBOC multiple times, lobbying for a continuation of the zero-risk weighting status of CDB bonds.51 In December 2008, the CBRC promised that CDB bonds could stay zero-risk weighted until the end of 2010, and their status afterward remained to be determined.52 This temporary support gave the CDB a moment to breathe.
What essentially slowed down the commercialization of the CDB was the aftermath of the global financial crisis, against which the Chinese government launched a 4 trillion-yuan stimulus package to revitalize domestic economy. The CDB was one of the major financial agencies assisting the government in restoring economic growth, lending massively to infrastructure and industrial projects. With such policy obligations, the CDB’s demand for sovereign guarantee for its funds became larger because without state support, it would be rather difficult for the bank to maintain a capital balance. For several years after the crisis, CDB officials requested a permanent state guarantee from the CBRC. From 2011 to 2013, the CBRC assigned the CDB temporary zero-risk weighting year by year, and in 2013, it extended the expiration date to the end of 2015. The credit guarantee scheme was permanently formalized in 2015 by a document issued by the CBRC, indicating that the CDB would enjoy a sovereign guarantee forever.53
The formalization of state guarantees marked a more thorough adoption of the KfW’s fundraising mechanism, one that is based on the credit support of the national government. “It took me a decade to persuade the Chinese officials to have the state guarantee the CDB bonds,” Hans Reich, the former president of the KfW who had been a member of the CDB’s International Advisory Council since 1999, said in an interview. “State guarantee is one of the most important things for a development bank that serves public goals,” he said.54 But the borrowed German practice was localized in two aspects. First, the credibility of the CDB bonds is backed up by a CBRC document, which is effective primarily within the Chinese financial market, whereas the sovereign credibility of KfW bonds relies on the KfW Law and is acknowledged globally. Second, and related to the first point, the very origin of the CDB’s capital source is domestic savings, whereas investors of KfW bonds are international and diverse.
The Japanese savings-based practice, which explains most of the remaining portion of the CDB’s liabilities, significantly increased its presence in the CDB’s funding mechanism after the global financial crisis. The reason was twofold. On the capital-supply side, the central bank lowered the benchmark deposit interest rate multiple times in 2008 to stimulate growth. Loosened monetary policies increased liquidity on the market and allowed the CDB to raise more capital through deposits. On the capital-demand side, the State Council’s 4-trillion-yuan stimulus package incentivized both policy and commercial banks to expand their lending volumes. To disburse more domestic loans, the CDB needed to diversify its capital sources and enlarge the size of its deposits. In 2008, the bank launched a project it called the “Doubling Deposit Program.” By the end of the year, the CDB had a deposit volume totaling ¥360 billion, which increased by 128 percent compared to the previous year. Starting in 2012, the deposit pool was further expanded, incorporating “policy deposits” (zhengcexing cunkuan) such as the Social Security Fund, Housing Provident Fund, and fiscal deposits. The total deposit volume in that year exceeded ¥900 billion, accounting for 11 percent of the CDB’s capital sources.55 Now deposits from banks and corporations are the bank’s second largest source of capital (figure 1.2).
Unlike commercial banks, the CDB does not take deposits from individuals. Most depositors are either financial agencies that have a business collaboration with the bank or clients depositing money in the bank after borrowing loans from it.56 Usually, the cost of raising capital from the bond market was considerably higher than that from direct deposits. For example, the CDB’s 2020 annual report stated that the average interest rate of deposits by financial agencies was 2.98 percent, and for the CDB’s clients, it was only 0.66 percent, whereas the yield of bond issues was 3.43 percent.57
In the postcrisis era when there was an increasing demand for CDB loans to finance policy-oriented projects that normally had low profitability, reducing the cost of funding became an important issue for the bank. Yields of CDB bonds were determined primarily by the supply and demand of China’s bond market, whereas interest rates of deposits of China’s financial market were not fully liberalized. There was thus much more room to reduce the cost of funding through lowering the interest rate of deposits than through lowering the yield of bond issuance. As a source from the CDB explained, “The yield liberalization of China’s bond market occurred earlier than the interest-rate liberalization. For most of the CDB’s funding, the price is determined by the bond market. This made fundraising hard for us.”58 Coming from a major commercial bank, Hu Huaibang, who succeeded Chen Yuan as the CDB’s governor in 2013, announced in his first year in office that the CDB should seek every opportunity to increase the size of deposits.59 However, unlike long-term bonds that may have a maturity of over five years, deposits are relatively short term and can be withdrawn. Raising funds through savings thus could not meet the CDB’s needs to lend long term. Hence, deposits could be supplementary to bond issuance but could not substitute for the latter entirely.
To recap, the decade after the global financial crisis witnessed the reinforcement of the state’s role in the CDB’s fundraising process. The government’s failed attempt to withdraw its sovereign guarantee for CDB bonds showed that a funding mechanism completely free of state participation was infeasible for the policy bank. The increased proportion of deposits in the CDB’s liability structure demonstrates a rise of the savings-based Japanese practice in the bank’s fundraising mechanism and implies that when the CDB had to finance more policy-oriented projects, it could not rely on market-raised funds exclusively.
A Market of State Actors
Conventional wisdom perceives China as a “strong state,” but the evolution of the CDB’s funding mechanism shows it has a “weak” side. The central government was not able to mobilize sufficient capital to finance infrastructure with the fiscal system in the early 1990s. Policymakers sought market methods due to the weakness of the state’s fiscal capacity. They could have chosen to adopt a more state-coordinated practice, which was not uncommon for the funding of PFAs around the world, but they did not. For liberal reformers, strong state intervention was a synonym for inefficiency, and it did not make sense to adopt something that they intended to depart from—a centrally planned economy that the state channeled fiscal revenue to fund economic activities. As a result, the CDB ended up developing a funding mechanism that was not only more commercialized than it had been in the past, but also relatively market-driven in comparison with PFAs around the world. To put it in another way, the sovereign guarantee for CDB bonds, though an implicit subsidy, is a result of minimizing state involvement in development finance.
With the policy banks’ auction-based funding mechanism, the state no longer determines the cost, volume, or destination of development-finance credits—these tasks were mostly handed over to the interbank bond market. Despite the fact that many of its dominant actors are state-owned, the market does have its own autonomy and responds to a supply-demand mechanism. When the CDB bonds were about to lose the state’s sovereign support in 2007, investors responded immediately with drastically declining purchasing demand. When the CDB attempted to reduce its cost of funding after the global financial crisis, it chose to seek alternative capital sources by enlarging its volume of deposits, as the bond market was an established market with its own rules and the CDB could not lower the cost of its bond issues easily despite its prominent status on the market.
On the other hand, the declining demand for CDB bonds in 2007 demonstrates the fact that this funding mechanism is grounded in state support. It is the sovereign guarantee that incentivizes investors to hold policy-bank bonds and allows bond transactions between policy banks and investors to take place. Compared to the global bond market where the KfW raises most of its funds, China’s interbank bond market appears less international, in that most participants are domestic actors. The privilege China’s banking regulatory body gives to the policy banks is acknowledged mostly within China and among the Chinese financial agencies, many of which are state-owned. But to build an interbank bond market from scratch, these agencies were what China had to begin with. Before the late 1990s, China did not even have a market that could allow agencies to trade bonds with one another. The emergence of the interbank bond market, therefore, shows a nexus where state and market interests converge.
We use cookies to analyze our traffic. Please decide if you are willing to accept cookies from our website. You can change this setting anytime in Privacy Settings.