The Right Connections

Last week it was announced that Reliance Communications, the mobile telecoms arm of the Reliance conglomerate 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’s credit worthy, they approve the loan. But this loan is not ordinary. It is between two large emerging markets. The company involved is one of the largest in India and it's controlled by one of India’s best connected businessmen, Anil Ambani. The banks are not average as well, they are owned by the Chinese government.

Anil Ambani’s Reliance Communications had a $1.2 billion convertible bond, which was due to be repaid in March, 2011. This was a problem. Reliance has a reported debt of $7bn. And because shares in Ambani's telecoms, infrastructure, power and financial services company were falling since the bond was issued in 2007, by more than half last year alone, few holders elected to convert and the bond had to be repaid in full.

Loans from traditional lenders like American and European banks would have been difficult due to the economic conditions in Europe, India’s high interest rate and the falling rupee. But these problems do not concern 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 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, and 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 Group’s October 2010 order for $10bn worth of energy equipment from Shanghai Electric Group, a deal also financed by state-owned Chinese 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. This is often exchanged for building infrastructure like roads, railways, power plants and bridges that help Chinese companies extract the commodities. The infrastructure is also built by state-owned Chinese 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 rules. In Africa, Chinese projects have been criticised 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 the government with ignoring labour law violations in exchange of political funding. Not surprisingly, the Chinese were not amused. The company's 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 per cent may not have been such a good deal for the Chinese lenders, but this is not all that matters. 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. Maximising 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.

Email the writer: