India Inc could pay a high price for 'cheap China loans'

Indian companies, which are facing a drought of funding options overseas, particularly after the recent downgrade of the US sovereign rating, are eyeing cash-rich China as a likely guardian angel.

At a recent meeting with Finance Minister Pranab Mukherjee, they have put forward a suggestion that the external commercial borrowing (ECB) facility be extended to cover renminbi loans from Chinese lenders. A high-level committee is to decide on that suggestion at a meeting on 15 September, Indian Express reports.

The companies, burdened by high interest rates in India, hope to benefit from low-cost finance from Chinese lenders in the same way that Anil Ambani did last year when he secured a $3 billion loan to part-fund a $10 billion deal for the purchase of power equipment from a Chinese state-owned company.

And since China too is looking to internationalise its currency, and since these renminbi ECBs will service similar power and telecom equipment deals with Chinese companies, the Indian government may be persuaded to see this as a “win-win proposition”.

After all, India has a serious power deficit, and if the companies can gain access to cheap credit overseas, they will be able to accelerate their desperately needed projects.

Several other Indian companies, which are staring at a severe crisis when their foreign currency convertible bonds of over Rs 30,000 crore come up for redemption by 2013, are similarly looking to tide over the crisis with loans from Chinese lenders to lower their borrowing costs.

Everyone, it appears, is looking to Chinese moneybags to bail them out.

The high cost of ‘cheap loans’

But in the stampede to secure ‘cheap’ Chinese loans, Indian companies - and perhaps even the Indian state - could end up paying a high price, going by the experience of other entities in other countries that similarly entered into ‘concessional’ loan agreements with Chinese lenders.

That concern arises owing to several reasons. The vehicles for China’s loans to overseas corporations - principally China Exim Bank and China Development Bank (CDB), from which Ambani secured his low-cost loan - are state-owned ‘policy banks’ with the express mandate to “advance China’s national interest.”

CDB, observes Erica Downs at the John L Thornton China Center at Brookings, “is a link between the strategic ambitions of the Chinese government and the commercial interests of Chinese firms because the financing it provides to support cross-border deals connects state policy to commercial activity.”

And although China frequently claims that its “concessional loans” come without strings attached, they in fact come with specific conditionalities that often work to advance Chinese strategic and commercial interests at the cost of the borrowers’.

Unreliable lender

Since the mid-2000s, CDB has participated in some of China’s most high-profile cross-border deals. Yet, it has not always been a reliable ’lender’.

The case of Indonesian state-owned power company PLN, which entered into an arrangement with China Exim Bank, CDB and Bank of China to finance a $8 billion project to build a dozen coal-fired power plants, is illustrative. The project was to have been completed by 2011, but in January 2009, the Chinese lenders, who had until then lent only $2 billion, suspended the rest of the loan tranches.

The reason? According to Indonesia’s Energy and Mineral Resources Minister, the project had been “taken hostage” by the Chinese lenders in order to put pressure on the Indonesian government to settle an unrelated commercial dispute between an Indonesian airline and a Chinese commercial aircraft manufacturer.

Chinese officials told Indonesian leaders that only if the airline dispute, which had nothing to do with the PLN project, was settled to China’s advantage would the other loan tranches to the power project be released.

Additionally, the Chinese lenders wanted Indonesia to agree to higher interest rates on the loans for the PLN project .

Only after the airline dispute was settled to China’s advantage was the lending for the PLN power project resumed; but by then the project was delayed and its cost had escalated.

“The case suggests that large-scale Chinese financing in developing countries can confer leverage on Chinese state-linked financial institutions that extends across projects in the same recipient country,” noted Mikael Mattlin and Matti Nojonen at the Bank of Finland.

The researchers point out that contrary to China’s claims that Chinese loans and investments in developing economies come without any conditionalities, in fact, “China is certainly not above attaching conditions to lending.” Most conditions are likely not imposed by a unitary state actor but emerge from the voluminous business activities of Chinese state-linked lenders and enterprises in developing countries, they add.

The broader concern, they say, relates to the extent to which China uses its growing financial power to gain commercial or political leverage. In other words, Chinese lenders offer ‘soft’ loans as bait for overseas corporates, and once the borrowers are hooked, the lenders then proceed to advance Chinese strategic interests.

Similar expressions of concern that Chinese loans may not serve the borrowers’ interests have been heard from Ghana (as in many parts of Africa) and from Sri Lanka .

Selling themselves short

So what could go wrong if Indian companies, desperate for a credit lifeline, sell themselves short to Chinese lenders?

The risk is that, as happened in the Indonesian case, when disputes arise between Indian and Chinese entities, the Chinese lenders will leverage their enormous hold on the Indian companies to settle the disputes to the advantage of the Chinese entities.

Chinese telecom equipment makers have in the past had trouble with the Indian establishment on security-related matters; even power projects in India built by Chinese companies have run into controversies . In such eventualities, the space for the Indian agencies to establish their case will be constrained if Chinese lenders extract their pound of flesh from the Indian companies that are indebted to them.

Even in the absence of disputes, Chinese lenders, principally CDB and China Exim Bank, have been known to advance Chinese strategic interests, even when the loans they advance were in the commercial space.

In that context, it’s worth bearing in mind that there’s a hidden cost to the ‘cheap China loans’ that Indian companies are queuing up for. It’s not all win-win as might appear on superficial consideration.