Question

Please write a summary. The article about reasons for the rising Cost of Capital in China and found it both interesting and appropriate.

"Poor policy lies behind China’s rising cost of capitalBy Paul J Davies in Hong KongWealth management products are a slippery stepping stone China Development Bank is the core policy bank in China. It has more than Rmb6tn ($984bn) in assets, is wholly owned by the state and is as good for its money as the government itself. So when CDB is forced to slash the size of a proposed bond issue by 60 per cent, as happened this month, you can be sure something is not right in China’s credit markets.Other respected and credible companies have also been forced to delay or reduce bond issues, or pay more for their money. Take US-listed internet group Baidu. Last year, it sold a bond to US investors that was priced without the extra that emerging market borrowers usually pay. But in recent months, it struggled to get a Chinese bond away. China’s cost of capitalhas begun to rise even though the government seems some way from the liberalisation of deposit rates that has held down borrowing costs for so long. Banks must already pay more for funds in the interbank market. Meanwhile, wealth management products(WMPs) –short-term savings products sold mostly by banks to retail and institutional investors –and trust products continue to grow. Both are currently offering better returns than straight corporate bonds to all investors, including banks themselves. The issue here is less about the rising cost of money –which is inevitable as markets come toplay a “decisive” role in China, as the post-Plenumbuzzword has it –than it is about bad policy, or at least the consequences of slow policy.With financial reform, Beijing may be gracefully “crossing the river by feeling the stones” as advocated by late paramount leader Deng Xiaoping, but it is simultaneously turning a blind eye to jerry-rigged fording devices, like WMPs, just down stream. Plenty of ink has been spilled on the risks tied up in WMPs, but much less on what they are really there to do. Their role is to begin to allow market forces to affect the cost of money for banks and companies ahead of interest rate reform; WMPs also legitimise investments that have not yet been officially approved, or are banned in banking channels. They do this simply by being an intermediary, or wrapper around the banned products.Hence, they have been used to supply high-cost capital to property developers, as well as some state-owned enterprises after banks were told to stop lending to them. More recently, they have moved on to investing in hedge funds. Managers and their friends or family put up the first chunk of equity, then WMPs add up to four times that in leverage, say Shanghai hedge fundspecialists. This allows insurers, for example, to indirectly invest in funds that officially they should not. One of the great oddities in Chinese financial policy is that liberalisation happens as much negatively as positively. Companies like the financial arm of ecommerce group Alibaba have found that the way to develop products is often to start using them and see if someone tells you to stop. It can lend to small businesses but was warned away from early trials of consumer loans. Financial innovation is rarely given preapproval, bankers say. The industry is forced to “feel the stones” in the absence of clear policy. Surely Deng’s metaphor was about discovering what works, not what would gain official sanction.Viewed optimistically, WMPs have introduced a market for funding, lending and investing that ought to help banks and others learn to assess risks and to balance changeable costs and returns. However, their role in legitimising not yet sanctioned, or already banned, activities just adds to the inefficiency and costs in the distribution of Chinese capital. The power of each new yuan to generate economic growth is waning. The leakage of costs through extra layers of WMPs makes this worse. China’s cost of capital will rise, but it does not have to rise that much. Interest costs track gross domestic product growth rates, according to analysts at Bernstein Research. If China grows at 6-7 per cent for the next few years, new debt for good companies ought not to cost much more –so long as it is dispensed reasonably efficiently.For this to happen, the single most important reform would be market pricing of deposit rates. This will be dangerous for banks,as Jiang Jianqing, head of ICBC, China’s biggest bank, told the Financial Times recently: “If you do badly, you will be wiped out.”But finance keeps moving away from official channels –around one-fifth of credit was formed outside of banks in 2009; now that share has doubled, according to Bernstein. To protect the banks, Beijing must move slowly; but if it moves too slowly, good companies could be starved of reasonable funding –and it runs the risk that China’s financial river will end up clogged with the detritus of too many bad experiments outside the banks.Paul J Davies is Asia Finance Correspondent"

Please read it and share your thoughts. Write more than 400 words, and giving references.

Answer 1

Chinese Development bank is sitting on huge foreign exchange reserves ($984 billion). However, CDB is directing banks not to lend lo certain like Property. Chinese financial policy is not able to control wealth management products(WMPs) that are formed.These WMPs are providing capital to many businesses which are capital starved. They are charging higher and hence cost of capital is rising.( Refer: But finance keeps moving away from official channels –around one-fifth of credit was formed outside of banks in 2009; now that share has doubled, according to Bernstein).

CDB should frame policies which are in line with present policies of lending all over the world. It is also significant that Chinese bonds are not getting adequate response in the world mainly due to lack of trust in Chinese policies.

China should be wary of risky investments but too much caution will be derogatory to whole world of capital.