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Corporate Jan 18, 2012

Anil bhai, what will that 'cheap China loan' really cost you?

By Venky Vembu

2011 has not been a great year for Anil Ambani.

The companies in his telecom-to-energy conglomerate are sitting on a mountain of debt, a chunk of which is denominated in foreign currencies and is coming up for redemption; three of his executives at Reliance ADAG were implicated in India's biggest corruption scandal, and he himself had to suffer the ignominy of an informal chat with the CBI; stocks of his companies have been battered down; attempts to sell parts of his business to raise funds to retire debt have not yet fructified; fresh borrowing costs have shot up, and have been compounded by the sharp fall in the rupee in recent months; and, in recent days, he has even been the victim of an anonymous defamation campaign.

About the only good thing to happen to the group was a lessening of tensions with brother Mukesh Ambani, but the vultures were circling overhead anyway.

And just when the perfect storm of bad karma was threatening his empire, Anil has been thrown a lifeline.

Anil Ambani

2011 has not been a great year for Anil Ambani. Punit Paranjpe/Reuters

It comes in the form of a $1.2 billion loan to Reliance Communications (RCom) from three Chinese state-owned banks - the China Development Bank (CDB), the Export Import Bank of China, and the Industrial and Commercial Bank of China (ICBC).

This is, in fact, the second time RCom has borrowed from Chinese banks; last March, Anil borrowed $1.9 billion from the CDB, much of whose proceeds were used to purchase telecom equipment from China's Huawei Technologies.

According to HSBC, the latest loans will help Reliance Communications cap its interest expenses at 5 percent, compared to the dollar funding cost of 6.8 percent.

Analysts point out that this is a really, really big deal - not just for Reliance, but also for other Indian corporates, since they too face redemptions on their foreign currency convertible bonds (FCCB), and would have been slammed if Reliance hadn't been able to secure the finance.

Raj Kothari, a convertible trader based in London, told Bloomberg that "If Reliance Communications had defaulted, the whole Indian convertible market would have collapsed".

Juergen Maier, a fund manager at Raiffeisen Capital Management, noted that "without the Chinese, they (Reliance) would have been in big trouble.. The Chinese are the last lenders left..."

What's in it for the Chinese?

Since there's no such thing as a free lunch - or an ultra-cheap loan - what are the Chinese banks' motives in taking a large bet on Anil's empire?

For one thing, the primary vehicles for China's loans to overseas corporations - principally the ExIm Bank and CDB, from which Ambani secured his low-cost loan - are state-owned "policy banks" with the express mandate to "advance China's national interest."

China has been using these banks as the advance vehicle to leverage its financial muscle to expand its exports to developing economies at a time when its primary export markets - in the US and Europe - are shrinking. China is also looking to graduate from low-cost made-in-China "junk" to higher-end exports, such as telecom infrastructure and equipment needed in energy projects.

For instance, the loan that Anil secured last year was used to part-finance a $10 billion deal to purchase power generation equipment from the state-owned Shanghai Electric; it was then billed as the "largest single business transaction" between India and China.

Given the significance of that deal, Shanghai Electric offered the equipment at a 30-40 percent discount (relative to what, say, a General Electric, would have offered). The preferential-interest rate loan lowered that discount even further, to about 60 percent.

To that extent, these cheap loans may appear to be a win-win proposition for both sides.

But there's a catch

But in the stampede to secure 'cheap' Chinese loans, Anil Ambani - and other companies who are contemplating similar deals - could also end up paying a price, going by the experience of other entities in other countries that similarly entered into 'concessional' loan agreements with Chinese lenders.

CDB, observes Erica Downs at the John L. Thornton China Center at Brookings, "is a link between the strategic ambitions of the Chinese government and the commercial interests of Chinese firms because the financing it provides to support cross-border deals connects state policy to commercial activity."

And although China frequently claims that its "concessional loans" come without strings attached, they in fact come with specific conditionalities that often work to advance Chinese strategic and commercial interests at the cost of the borrowers'.

Since the mid-2000s, for instance, CDB has participated in some of China's most high-profile cross-border deals. Yet, it's not always been a reliable 'lender'.

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The case of Indonesian state-owned power company PLN, which entered into an arrangement with China Exim Bank, CDB and Bank of China to finance a $8 billion project to build a dozen coal-fired power plants, is illustrative. The project was to have been completed by 2011, but in January 2009, the Chinese lenders, who had until then lent only $2 billion, suspended the rest of the loan tranches.

The reason? According to Indonesia's Energy and Mineral Resources Minister, the project had been "taken hostage" by the Chinese lenders in order to put pressure on the Indonesian government to settle an unrelated commercial dispute between an Indonesian airline and a Chinese commercial aircraft manufacturer.

Chinese officials told Indonesian leaders that only if the dispute was settled to China's advantage would the other loan tranches to the power project be released.Additionally, the Chinese lenders wanted Indonesia to agree to higher interest rates on the loans for the PLN project.

Only after the airline dispute was settled to China's advantage was the lending for the PLN power project resumed; but by then the project was delayed and its cost had escalated.

"The case suggests that large-scale Chinese financing in developing countries can confer leverage on Chinese state-linked financial institutions that extends across projects in the same recipient country," noted Mikael Mattlin and Matti Nojonen at the Bank of Finland.

The researchers point out that contrary to China's claims that Chinese loans and investments in developing economies come without any conditionalities, in fact, "China is certainly not above attaching conditions to lending." Most conditions are likely not imposed by a unitary state actor but emerge from the voluminous business activities of Chinese state-linked lenders and enterprises in developing countries.

The broader concern, they say, relates to the extent to which China uses its growing financial power to gain commercial or political leverage.

Similar expressions of concern that Chinese loans may not serve the borrowers' interests and may be a "Trojan Horse" to promote Chinese commercial and strategic interests have been heard from Ghana (as in many parts of Africa), Sri Lanka, Belarus and Tonga.

Selling themselves short

This does not mean Anil Ambani's group is going to face any such problem. However, the risk is that, as happened in the Indonesian case, when disputes arise between Indian and Chinese entities, the Chinese lenders will leverage their enormous hold on the Indian companies to settle the disputes to the advantage of the Chinese entities.

Chinese telecom equipment makers have in the past had trouble with the Indian establishment on security-related matters; even power projects in India built by Chinese companies have run into controversies. In such eventualities, the space for the Indian agencies to establish their case will be constrained if Chinese lenders extract their pound of flesh from the Indian companies that are indebted to them.

Even in the absence of disputes, Chinese lenders, principally CDB and China Exim Bank, have been known to advance Chinese strategic interests, even when the loans they advance were in the commercial space.

It will be interesting to see whether Anil Ambani will face pressures from the Chinese to help with their political lobbying. In recent years, the import of thousands of illegal, unskilled Chinese labourers had become a source of friction between the two countries. The Indian government had then disallowed the issuance of Indian visas for unskilled and semi-skilled labourers from China.

Given the financial situation of the Anil Ambani group, there's no way to know how the Chinese will use their leverage to further its own interests in India.

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by Venky Vembu

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