China is about to pump billions of dollars through state-owned banks to save the domestic economy. But will it work? That depends on whether the banks know when to lend – and when not to. The fallout from the failed $66bn takeover of miner Rio Tinto suggests they have much to learn.
China Development Bank (CDB) helped Chinalco, the Chinese state-owned mining group, buy a 12pc stake in Rio in February. Chinalco spent $14bn on the shares, cheered on by Chinese steel makers who feared a takeover of Rio by rival BHP Billiton might leave them at the mercy of the enlarged metals giant.
BHP’s bid for Rio indeed foundered this week – albeit not because of Chinalco – sending Rio’s shares tumbling 37pc in a day. Chinalco now nurses a horrible loss. Its $14bn investment is worth a paltry $3bn.
That could be even worse for CDB than it is for Chinalco. The state bank lent Chinalco $6bn up front, plus a $7bn facility of which $2bn had been drawn but not used when the shares were purchased, according to US regulatory filings. That makes for $8bn lent against assets which, today, are worth less than half that amount.
Assuming $8bn of loans drawn, Chinalco would owe $260m of interest this year. Dividends paid to Chinalco from Rio, though, are unlikely to top $200m. Worse, $1.8bn of borrowings are due for repayment in January 2009.
If CDB still holds those loans, it has several unappealing options. It could seize the shares; force Chinalco to sell assets; or swap its loans for Chinalco equity. The last may be the least embarrassing for the politicians who sit on Chinalco’s board. Any of these options suggests an embarrassing write-down for CDB.
But if the history of Chinese banking is any guide, CDB might be tempted to lend Chinalco even more. That would hardly augur well for the government’s planned fiscal stimulus. China’s lenders, CDB included, are poised to disgorge masses of new loans to maintain the nation’s growth. They need to show they can tell a good investment from a bad one.
By John Foley, breakingviews.com
Last Updated: 6:11PM GMT 26 Nov 2008
Source: The Telegraph