China's "Bad Bank" for Ag Commodities

Now, here's a business plan: lend billions of dollars to buy items at higher prices than competitors pay and store the merchandise in warehouses. Then watch the market price of the items you financed drop. Sell the merchandise four or five years later after it has deteriorated to the point that no one wants to buy it.

This is basically the business plan of the Agricultural Development Bank of China, a "policy bank" that finances purchases of grains and cotton at support prices on behalf of the government.

The ADBC has announced that it has allocated 300 billion yuan (US$ 49 billion) to finance the purchase of fall-harvested grains--mainly rice, corn and soybeans. The prices of both commodities are far above the prices in global markets, and there is downward pressure on Chinese prices. Chinese farmers are said to be eager to sell their grain as fast as possible because they expect prices to fall as the season goes on.

Soybeans kept in storage since 2010 and 2011--financed by ADBC--were offered for sale in a Chinese auction last week but less than 15 percent of the beans found buyers. Soybean prices have been dropping, so it's unclear why they chose to sell the beans from reserves at this time. Authorities have been offering millions of tons of corn for auction every week, but most goes unsold due to poor quality and bad location. Auctions demand a starting price that covers purchase price plus storage costs--a price that exceed the current market price.

The ADBC also announced 60 billion yuan (US$ 9.8 billion) allocated for purchasing cotton this fall. ADBC has already financed a massive reserve of 11 million metric tons of cotton--more than a year's consumption--by purchasing most of the country's last three cotton harvests at prices that are, again, far above the world price. This year, officials say they are going to let the cotton price fall to a market price that equilibrates supply and demand. As the cotton price falls, the value of the cotton inventory falls.

Earlier, ADBC announced 165 billion yuan (US$ 28.9 billion) to finance the purchase of summer grain--wheat, rapeseed, and the early-season rice crop. The wheat and early rice crops exceeded demand and required authorities to stockpile 25.3 mmt of wheat and 3.8 mmt of early rice to support prices. This summer, authorities tried to auction wheat from previous years that they admitted had excessive levels of mold.

ADBC's total funds for purchasing summer and fall grain and cotton equal 530 billion yuan (US$ 86 billion).

According to one article, from 2004 to 2013, ADBC issued funds totaling 2.757 trillion yuan (US$ 448 billion at current exchange rate) to finance grain purchases.

According to its annual report, ADBC loans financed 61 percent of grain purchases and 67 percent of cotton purchases during 2013, its biggest-ever year. The report showed a trend of rising profits from 2004 to 2013, based on interest payments from state-owned enterprises holding commodities. It claimed to have only 0.7% nonperforming loans. But profits should turn into losses this year as prices plummet and the true value of the assets financed by the loans is realized.

Several months ago, Chinese authorities said policy banks like ADBC and the Export-Import Bank would be the next target for reform of financial institutions. Plans are vague so far, but seem to entail a retreat from financing commodity stockpiles for market intervention. Instead, ADBC will shift toward financing infrastructure and rural business loans.