Friday, April 4, 2014

Agribusiness Credit: Feast or Famine

Chinese agribusiness is "feast or famine" when it comes to financing. Companies like COFCO and WH Group (formerly Shuanghui International) have seemingly limitless financial resources to go on multi-billion-dollar spending sprees. But most of China's agribusiness companies--including those that sell on the global market--are strapped for cash.

"Financing problem and countermeasures of agricultural products exporting industry," a January article in the Chinese publication International Financing -- available at this site (with sleazy ads) -- summarizes the problems faced by Chinese agricultural-exporting enterprises in financing their businesses.

The author observes that the hot growth in China's exports of agricultural products followng WTO accession in 2001 came to an abrupt halt after the global financial crisis in 2008-09, and has had difficulty recovering.

The author notes that the macroeconomic environment has been difficult for ag-exporting companies in China. Global demand weakened after 2008-09, the Chinese currency appreciated, and they saw rapid increases in agricultural prices, labor and input costs that eroded Chinese companies' international competitiveness.

The author cites so-called "green barriers"--foreign-country standards and chemical-residue tolerances that allegedly discriminate against Chinese products. However, he also acknowledges that Chinese companies do have quality problems because small, fragmented farms turn out raw materials that vary widely in quality and grades, companies use traditional "backward" management, China has varying quality standards, and he admits some ag products do have excessive residues from pesticide and fertilizer.

The article's main point is that trouble financing their business is one of the chief constraints on China's agricultural exporters. Only a few companies favored by the Government or foreign investment bankers are able to raise capital by IPOs and bond offerings. Bank loans are the chief source of financing, but most companies have trouble getting bank credit as well.

One reason is that most of the exporters of agricultural products are predominantly small, privately-owned companies. Most of have sales in the $1-to-2 million range, and many have annual sales under $1 million. Companies based in central and western provinces are smaller than those on China's east coast.

The financing problems are partially due to the peculiarities of agricultural-related businesses. In comparison with industrial enterprises, agricultural exporters face relatively slow-growing markets and high risks from pest or weather losses, spoilage of perishable commodities, and price swings. Potential lenders shy away from such high-risk business.

Most companies procure large volumes of agricultural raw materials and process them into low-value-added generic products.

The companies' cash cycle is mismatched with banks' lending cycles. Companies have large seasonal cash needs to purchase raw materials when they're harvested, while the revenue stream is spread over a longer period. Farmers who sell the raw materials want to be paid in cash -- they have even weaker access to credit -- so there are enormous seasonal needs for working capital.

Agribusiness companies lack collateral that can effectively secure loans. Banks or third-party guarantors are not inclined to accept agricultural commodities as security since they are bulky, stored in remote locations, illiquid, vary in quality, and prices fluctuate. Agribusiness companies have few fixed assets to secure loans--buildings and equipment also tend to be in remote locations and have low market value.

Many agricultural-processing companies are located in small cities and towns where banking is poorly developed. Their location also makes it hard for bankers to verify information, and it's costly to service loans for far-flung borrowers. Bankers don't trust small companies that often have chaotic, "nontransparent" accounts, evade taxes, and have weak management mechanisms.

The author recommends a mix of policies to address these credit issues.  He proposes that government and industry associations serve as a platform to improve the reputation and credibility of agribusiness companies. He also calls on companies to clean up their accounting and control their internal finances. The author recommends policy-style banks like the Import-Export Bank and Agricultural Development Bank give special financing, and the government should set up a special fund for exporters. He says the government should foster innovation in the loan guarantee business.

The main prescription--policy-type banking--actually works against small businesses. In an economy where interest rates are inflexible, policy banking inevitably becomes a rationing mechanism that channels credit to politically-connected borrowers. This is how China's rural banking system became dysfunctional in the first place--banquets and bribes were essential to getting loans from the 40,000 "rural credit cooperatives." These "cooperatives" were initially set up to finance communes in the 1950s and are still the titular backbone of rural banking, but in actuality they served as ATMs for the well-connected. They are being consolidated and reborn as rural commercial banks, but it's unclear whether their management has been fundamentally changed.

China's current overall debt problems derive from excessive lending by State banks to industries like cement, ship-building, metal working, and solar panel manufacturing that created excess capacity and a corporate debt burden. Less well-known is excess capacity in oilseed-crushing that resulted from handing out cash to state-owned companies to build new plants starting in 2009 as a strategy designed to dilute the share of crushing capacity held by multinational companies. There is similar overcapacity in meat processing and other agribusinesses where "policy finance" at the local level has financed big mechanized plants in nearly every county. In these industries there are frequent calls to "raise the threshold" for the industry--to cut excess capacity by eliminating the small agribusiness companies this article is worried about. Thus, the ultimate end of policy finance is to create oligopolies of well-connected companies.

Financing problems cascade from the bottom up. Rural land and houses can't be used as collateral, so farmers have no way of securing loans, so they demand cash payment from agribusinesses. Legal ambiguities and selective enforcement of laws encourage flouting of laws, subterfuge and duplicity that makes all borrowers potentially untrustworthy and limits lending to those with personal connections to bankers. Rates on loans are capped, so lenders can't legally charge rates that will cover their risk. So lending is pushed into the "shadow"-banking sector where there are no limits on rates. Futures markets function mainly as casinos for speculators with weak links to fundamental supply and demand, so they can't be used to hedge risk.

Looking at the financing chain also reveals why China's agribusiness sector may be facing a bigger systemic risk than most people realize. As long as agricultural prices were rising every year, the system functioned OK. The commodities agribusinesses owned always went up in value; loans were repaid. But as prices go down, the commodities fall in value. The chain of grain depots, warehouses, processors, and lenders can no longer keep the cash flowing and may fall into insolvency, causing the whole system to lock up.

News media reports of billion-dollar shopping sprees by the few anointed companies--the 1% of Chinese agribusiness--is diverting attention from festering problems among the 99% in China's agribusiness sector.

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