Party Loyalty in China Helps Private Companies Get Cheaper Loans

(Bloomberg Businessweek) --

President Xi Jinping has overseen a resurgence of party influence in China over everything from corporate boards to houses of worship, famously using a phrase from Mao Zedong: “East, west, north, and center—the party leads everything.” Nowadays it appears China’s Communist Party even controls which private companies get bank loans.

To accumulate political capital, Qiu Rongquan, chairman of Zhejiang Taida Miniature Electrical Machinery Co., says he began making a concerted effort to promote the party at work about four to five years ago. Now 12 of his 170 employees are members. He encourages his staff to use an app called Xue-Xi-Qiang-Guo, or “Study Xi to Strengthen the Country,” which touts Xi’s doctrines. “The party-building work has paid off,” Qiu says. “We have got the government support. It means a lot.”

The maker of ventilating fans was granted a so-called red loan under a new local government program that rewards successful companies that promote the party. Taida, in Deqing county in Zhejiang province, pays the benchmark interest rate of 4.35 percent on its 3 million-yuan ($445,500) loan. Usually, it would have paid 20 percent to 30 percent more, Qiu said in an interview at the Canton Trade Fair in April.

Local officials say the loans are part of an effort to funnel more credit to efficient private companies instead of wasteful state enterprises. Critics see it differently. “It’s not obvious that being familiar with Xi Jinping thought makes a firm economically more efficient,” says Michael Spencer, global head of economics at Deutsche Bank AG in Hong Kong. “Examples such as this will encourage weak firms to bone up on political theory in hopes of getting similar benefits.”

While the scale of red loans is small so far, the concern is they could undermine progress in the government’s drive to curb financial leverage. With China’s debt approaching three times gross domestic product, authorities are trying to keep a lid on the pace of credit growth, making it all the more important that loans are allocated efficiently. Xi said last year that curbing borrowing by state-owned enterprises should be “the priority of priorities,” while state media have called the buildup of risk in the financial system the “original sin.”

Party Loyalty in China Helps Private Companies Get Cheaper Loans

The banking sector hasn’t been spared an upsurge in party influence. Two years ago, lenders including Industrial & Commercial Bank of China Ltd. and Agricultural Bank of China Ltd. modified their bylaws to give the party more oversight of management decisions. And when China Banking and Insurance Regulatory Commission chief Guo Shuqing told banks late last year that at least a third of all new credit must go to private companies, banks immediately complied. The largest institutions dramatically increased loans to small private businesses, with some even cutting interest rates to close to unprofitable levels, a move that sent their stocks tumbling.

Overall, Xi has tightened financial regulation, cracking down on outfits that operate as shadow banks and pledging to hold local officials accountable “for a lifetime” if they take on too much debt. That’s no idle threat considering how much influence the party wields over the career trajectories of even the lowliest government functionaries. “This seems perfectly typical of the current moment in China,” says Barry Naughton, a professor at the University of California at San Diego who specializes in the Chinese economy. “Two absolutely contradictory trends: one to move toward more financial instruments as a more effective and market-oriented way to achieve results, the other to move toward ever greater politicization and ever more precise and calibrated top-down control.”

Reports of red loans in Deqing county first surfaced in February. Huzhou city, which administers Deqing, expanded the program to five districts and counties in March. Huzhou city government said in a statement that its red loans are guarantee-and collateral-free, with reduced rates to help private companies grow. By mid-April, 51 million yuan in loans and 327 million yuan in credit lines had been offered to 54 companies. One got 5 million yuan for equipment in three days, the Huzhou government said.

Neighboring cities Taizhou and Jiaxing have followed suit. Red loans are now available in an area with a population of 14 million—more than Hong Kong and Singapore combined. The size of loans and their interest rates are based on an index that quantifies an organization’s party loyalty, the local government says. The criteria for scoring high on the index include participating in study groups, donating a portion of income to the party, and wearing pins with the party flag during business hours. Taizhou businesses scoring at least four stars out of five qualify for loans of 500,000 yuan to 10 million yuan.

“If you move toward a system where the most loyal party supporters get more money from the financial system, the outcome is not likely to be very good, either in terms of supporting economic growth or maintaining the health of the overall financial system,” says Nicholas Lardy, a senior fellow at the Peterson Institute for International Economics in Washington.

The nexus of business and party-supervised government in China is at the center of Donald Trump’s trade war. His administration says massive subsidies and other benefits for Chinese enterprises tilts the playing field unfairly against U.S. companies. As China moves into industries of the future such as robotics and new-energy vehicles, the fear is that its previous grab for market share in areas like solar panels will be repeated on a bigger scale. Numerous foreign companies, from SolarWorld AG to Suniva Inc., have filed for bankruptcy in recent years, citing competition from Chinese rivals that are backed by government subsidies and cheap funding.

“Foreigners don’t understand us Chinese people,” says Taida’s Qiu. “They think companies are not related to the government. But in China, businesses are always related to the government.”

To contact the editor responsible for this story: Cristina Lindblad at mlindblad1@bloomberg.net, Malcolm Scott

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With assistance from Bloomberg