Friday, January 17, 2014

Policy Bank Finances Ag Commodity Shopping Spree

The Agricultural Development Bank of China (ADBC) is injecting loans into China's countryside to make sure farmers can sell their commodities despite sinking prices. This looks like a financial crisis waiting to happen.

In the first week of January ADBC issued a notice to its staff urging them to do a good job on issuing credit for grain and cotton purchases as the new year starts.  Staff were ordered to increase their "political awareness" and sense of responsibility to ensure that farmers get good profits, keep grain and cotton markets stable, make that farmers can sell their grain and cotton and that farmers don't get paid with IOUs. 

The ADBC was spun off from the Agricultural Bank of China (ABC) in 1994 to fund government commodity procurement (allowing ABC to focus on commercial lending). ADBC slurps up funds from deposits from commercial banks placed with ADBC and by selling bonds, then lends out the money to state-owned grain and cotton procurement operations. With the government struggling to prop up prices this year, the bank's lending is booming. The ADBC notice issued this month emphasized the importance of issuing credit to support the "temporary reserve" purchase of corn and soybeans in northeastern provinces. 

ADBC's  outstanding loan balance at the end of 2013 was 2.5 trillion yuan (over $400 billion). It rose 14 percent from the previous year--about twice as fast as GDP growth. Loans for grain, cotton and oils purchased for reserves totaled 735 billion yuan ($120 billion) during 2013. 

In Xinjiang Autonomous region the ADBC financed 75 percent of cotton purchases during 2013. The volume of cotton it financed was up 8 percent and loan volume was record-high at 65 billion yuan (over $10 billion). Xinjiang accounted for three-fourths of all the cotton purchases supported by ADBC. 

ADBC's chief executive and party secretary explained the bank's important role in supporting the rural economy in light of the third plenum of the 18th party committee. The third plenum emphasized the decisive role of the market, but ADBC--a government policy bank--is expected to play the key role in mobilizing capital for modernizing agriculture and building new cities in the countryside. The rural banking system is barely functional as a financial intermediary since most farmers and small businesses have no assets to secure loans with. ADBC is expanding the scope of its business to include more lending to infrastructure and rural development projects. ADBC is also to give credit to Chinese agribusiness companies investing overseas to meet Chinese demand with "two markets, two resources." 

ADBC has a curious notion of market economics. Its January notice to staff said it is important for their credit to support "policy-style purchases" (at support prices) to "guide" market prices. In other words, the market price is wrong and the government-set support price is right. 

ADBC claims that its nonperforming loans are declining and its NPL rate is now just 0.71%. However, lending billions of dollars to buy cotton at prices 50% above the world price is not a healthy lending practice. The bank financed a large portion of the 35-million tons of corn purchases at support prices last year that are unsellable this year because prices have fallen. Another 40 million tons of corn is expected to be stockpiled this year. Grain stocks are reported to be at a record-high level--much of it financed by ADBC--and prices are falling. 

Conditions are quite similar to those in the late 1990s. At that time, the grain and cotton marketing system lost billions of dollars and the ADBC's nonperforming loan rate zoomed to 25-to-40 percent. This time, ADBC is just a small corner of China's cash-rich economy and it can keep propping up commodity markets as long as the cash keeps flowing. Remarkably, China's reserve-cotton-buying spree has continued for three years now, financed mostly by ADBC. But there is potential for lots of things to implode at the same time. If the flow of cash dries up ADBC will become part of the financial meltdown.

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