Good to have connections

Commercial strings are always part of the deal. Reliance Communication’s loan was made easier by its power arm’s October 2010 order for $10 billion worth of energy equipment from Shanghai Electric Group, a deal also financed by Chinese state banks

Last week it was announced that Reliance Communications, the mobile telecom arm of the Reliance Anil Dhirubhai Ambani Group (R-ADAG) in India had received a loan from three Chinese banks. Normally a loan by three banks to a large conglomerate would not be unusual. After all it happens all the time as part of regular business practices. This is what banks are supposed to do. They assess risk. If they find the borrower credit worthy, they make the loan. But this is loan is not ordinary. It is between two large emerging markets. The company involved is one of the largest in India. It is controlled by one of India’s best connected businessmen, Anil Ambani. Nor are the banks average, they are owned by the Chinese government.

Anil Ambani’s Reliance Communications had a $1.2 billion convertible bond, due to be repaid at the start of March 2011. This was a problem. Reliance has a reported debt of $7 billion. Since shares in his telecom, infrastructure, power and financial services company shares have fallen since the bond was issued in 2007, more than half last year alone, few holders elected to convert and the bond has to be repaid in full. Loans from traditional lenders like US and European banks would have been difficult due to economic conditions in Europe, India’s high interest rate and the falling rupee. But these problems are not of interest to Chinese banks. Their business model is a bit different.

Joseph Nye, an American professor at Harvard , coined the expression “soft power” 20 years ago. He defined it as “the ability to get what you want through attraction rather than coercion or payments.” Chinese state-owned firms are not necessarily out for profits. Part of their mission is directly related to extending “soft commercial power”.

The Reliance loan worked for this objective on several levels. First and most importantly for the Chinese is that it helped to establish a relationship. All emerging markets are relationship-based systems as Mr Ambani knew well. Like the elder Ambani, the Chinese use it for their profit. In a society with few rules and less transparency large networks of networks of family, friends, classmates, and especially (Communist) Party connections are a necessity.  

The Communist Party is especially involved with its state-owned business specifically its state-owned banks. In his book, “The Party”, Financial Times correspondent  Richard McGregor writes that the bosses of China’s 50-odd leading companies all have a “red machine” sitting  on their desks that provides an instant (and encrypted) link to the Communist Party’s leadership. Commercial enterprises for Chinese state-owned companies are a “continuation of politics by different means”

This is not to say that there is not a very definite commercial side to state directed moves by state-owned companies. No doubt Reliance’s loan was made easier by its power arm’s October 2010 order for $10 billion worth of energy equipment from Shanghai Electric Group, a deal also financed by Chinese state banks.

Commercial strings are always part of the deal. For example in Africa and South East Asia Chinese companies are looking for guaranteed supplies of oil or other raw materials. Often this is exchanged for building infrastructure like roads, railways, power plants and bridges that help Chinese companies extract the commodities. The infrastructure is also built by Chinese state firms, which hold four of the top five positions of the world’s largest contractors.

Many of these deals lack transparency, because they may involve bribes. Relationship based systems like China’s are never fond of the rules. In Africa, Chinese projects have been criticized for employing Chinese rather than local labour. When they do employ local labour, they can breach the rules as when managers in Zambia fired on a group of angry workers injuring 13. The Zambian opposition charged that the government had ignored labour law violations in exchange for political funding. Predictably the Chinese were not amused. The company executive complained that it was very difficult to do business in Zambia because “The opposition party always makes a big fuss over small problems.”

Still access to commodities and connections is secondary to profit.  Mr Ambani’s loan for an “extended” maturity period of seven years and an “attractive” interest rate of about 5% may not have been such a good deal for the Chinese lenders, but this is not all that important. China National Petroleum Corporation is one of only two companies to win contracts to develop Iraq’s oilfields for the simple reason that the royalties required by the Iraqi government made the deal of questionable value. Maximizing production is more important than profit.

Ultimately though making political concern dominant over profit does cost. If neither the Chinese banks nor Mr Ambani can allocate capital efficiently, the result will in time be a disaster.

(William Gamble is president of Emerging Market Strategies. An international lawyer and economist, he developed his theories beginning with his first hand experience and business dealings in the Russia starting in 1993. Mr Gamble holds two graduate law degrees. He was educated at Institute D'Etudes Politique, Trinity College, University of Miami School of Law, and University of Virginia Darden Graduate School of Business Administration. He was a member of the bar in three states, over four different federal courts and has spoken four languages. Mr Gamble can be contacted at [email protected] or [email protected])


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