VIII. TRADE AND PROJECT FINANCING A. The Banking System China's banking system is changing rapidly under the impetus of economic reforms. A summary description of its current configuration follows: At the top of the system is the central bank, the People's Bank of China, which sets monetary and, together with the State Administration for Exchange Control, foreign exchange policies. Below the central bank are the state-owned specialized banks: Bank of China People's Construction Bank of China Agricultural Bank of China Industrial and Commercial Bank of China Bank of Communications These banks were originally integral elements of the socialist economic planning system which functioned as conduits for state investment. They are now coming under increasing pressure to transform themselves into commercial banks and to operate more on market principles. In the midst of the reforms of the 1980's the government established some new investment banks which engage in various forms of merchant and investment banking activities. They are: China International Trust and Investment Corporation (CITIC) CITIC Industrial Bank Investment Bank of China Two new government banks were established in 1994: the State Development Bank of China and the Export-Import Bank of China. These banks will take up much of the financial responsibility for financing economic and trade development and state-invested projects included in the government's five-year economic plans. B. Foreign Exchange Controls China's central bank, the People's Bank of China, and the State Administration for Exchange Control regulate the flow of foreign exchange in and out of the country. In order to better control this flow, as of January 1, 1994, all Chinese enterprises and agencies are required to turn over all foreign exchange earnings to the banking system, in exchange for renminbi. When foreign exchange is required for import and other legitimate transactions, they then apply to designated banks that are members of the interbank foreign exchange market to purchase the funds. Foreign-invested enterprises (equity and cooperative joint ventures, and wholly foreign-owned enterprises, referred to as FIEs) are permitted to keep foreign exchange in their special forex accounts, but are excluded from the new interbank market. Accordingly, the Chinese government is retaining certain of the foreign exchange swap centers through which FIEs can trade foreign exchange and renminbi among themselves. There are indications that the new forex interbank market and the swap markets are gradually being integrated. Since the supply of foreign currency from time to time falls short of demand, continued government controls over its allocation still constitute a significant barrier to enhanced U.S. trade performance in China. Chinese end-users often have difficulty obtaining sufficient foreign exchange to finance imports. Foreign enterprises or joint ventures which do not generate export surpluses have trouble gaining access to sufficient hard currency to buy key inputs from overseas. The swap markets have provided some measure of enhanced liquidity, but are in no way an adequate or long term solution to the problem. They operate within strict limitations and sometimes have very little foreign exchange on offer, and only at a considerable premium. C. General Financing Availability There are now more sources of financing for imports and investment than at any time since China's initial opening to the outside world. They are: Central government reserves: The Chinese Government's official reserves now total about US$45 billion. The country's debt service ratio is well below the 20 percent benchmark set by most banks as the threshold between healthy and unhealthy international financial accounts. The World Bank: The World Bank, based in Washington, D.C., maintains a large loan program in China, primarily in key infrastructure industries such as transportation, power, energy, agriculture and the environment. The World Bank conducts its procurement by the rules of international competitive bidding through China National Technical Import Corporation or China National Instruments Import and Export Corporation. Tender announcements are published in the China Daily (English) and the People's Daily (Chinese). The Asian Development Bank: The Asian Development Bank, based in Manila, the Philippines, also conducts its procurement through international competitive bidding. Tenders are managed by the same Chinese trading companies which handle World Bank Loans. Again, the areas of emphasis are: transportation, energy and power, the environment and agriculture. The Overseas Economic Cooperation Fund (OECF) of Japan: The OECF is a Japanese government organization which extends financial assistance to developing countries. China is the second largest recipient of such assistance, after Indonesia. Japan's loan agreements with China usually coincide with the five-year economic plans. China is now drawing on the third yen loan, of about US$5 billion, which was designed to cover the eighth five-year plan (1990-1995). Project tenders are conducted under rules of international competitive bidding, which are different in some important ways from those of the World Bank. Tenders are announced in the Chinese press and are conducted, in most cases, by China National Technical Import Corporation. Bilateral government loans: One of the most intractable barriers to enhanced American trade performance in China were the predatory financial practices of foreign governments, many of which have active soft loan programs designed to support their country's exporters. U.S. firms, otherwise competitive on price and quality, sometimes lose contracts because they can not compete with the low interest, soft loans offered by European and other governments in support of their exporters. Although OECD negotiations concluded in the spring of 1992 succeeded in establishing criteria which are to supposed to govern the eligibility of projects in developing countries to receive tied soft credits. The soft loan business in China has not come to an end. The new rules were designed to curtail the competitive use of soft loans in an effort to channel aid funds to non- profitable projects. Under the OECD regime, if a project is commercially viable it is not eligible to receive soft loans unless procurement is conducted by means of international competitive bidding. Early in the life of the agreement, some projects actually were isolated from access to soft loans, particularly in the petrochemical industry, which turned to the use of export credits to put up some major projects. But it is widely acknowledged in business circles, both Chinese and foreign, that the agreement has had little influence over the flow of soft loans to profit-making projects. Foreign soft loans, then, remain a significant threat to American commercial prospects in China. D. Financing Exports/Methods of Payment General import payment practices are, for the most part, the same in China as in most other countries. Regardless of the source of financing there are usually two common payments mechanisms: letter of credit and "documents against payment." Letters of credit: Although the Bank of China dominates China's trade finance business, several banks, both Chinese and foreign, have the authority to issue letters of credit for Chinese imports. Other major Chinese banks operating trade finance businesses are the People's Construction Bank of China, Industrial and Commercial Bank of China, Agricultural Bank of China and CITIC Industrial Bank. Foreign banks with branch or representative offices in China (see Appendix C) can issue letters of credit as well. There are a few peculiarities about letters of credit issued by Chinese banks. First, China will not allow letters of credit issued by its banks to be confirmed by other banks, Chinese or foreign. Second, China is not a member of the International Chamber of Commerce and, therefore, is not subject to the Unified Customs and Practices (UCP) 400 code regarding international trade payments. Some Chinese practices may diverge from the practices established under the UCP regime. For example, Chinese banks usually release funds, not at sight, but only after the headquarters office in China receives and examines all of the trade documents. UCP rules require at sight payments from the branch office overseas, upon receipt of the full set of required trade documents. Although there are still standard letter of credit forms, terms and conditions are generally negotiable, and are now set on a transaction-by-transaction basis. Documents against payment: This method of payment is similar to a letter of credit, but less formal and more flexible. Just as with letters of credit, the exporter submits a full set of trade documents for payment collection to the bank designated in the contract. The Chinese bank will send the documents to the home office, which examines them and, in some cases, passes them to the buyer for further examination. Payment is made after the documents have met the approval of all parties. This method of payment provides rather thin coverage against default. It can be considerably less expensive than a letter of credit, but should be used with some degree of caution. Countertrade: There are no formal countertrade requirements, but the general shortage of foreign exchange available on the market (as opposed to that in central government coffers) has made it necessary for some Chinese entities to resort to countertrade to finance imports. This form of trade has seen increased emphasis recently in China's current free-wheeling trade and commercial environment, in the power sector, for instance, where import demand far outstrips hard currency supply. Countertrade can be difficult. Most companies that make a product attractive to foreign buyers will want to sell to foreign customers directly to earn their own foreign exchange, rather than sell, for local currency, to a foreign company. Success in this business requires a global trading network and a good deal of patience. E. U.S. Export Financing and Insurance Export credits: The pool of soft loans is not without a bottom. In the context of China's high-speed growth, financing is needed as never before and Chinese end- users have become more interested in using foreign export credits to finance imports. The rates and terms of such loans are governed by the OECD agreements on export credits. Lending rates are set either at the OECD matrix rate or at the commercial interest reference rate, whichever is lower. The Export-Import Bank of the United States (Eximbank) offers a full range of export loans and loan guarantees for companies exporting products with at least 51 percent U.S. content. The bank works regularly with Bank of China and the People's Construction Bank of China, and will work with other banks, including China International Trust and Investment Corporation and the China Industrial and Commercial Bank, on an ad hoc basis, assuming full faith and credit guarantees as available from the Chinese government. Insurance: The China operations of the Overseas Private Investment Corporation have been under suspension since the Tiananmen incident of 1989. No United States government investment risk insurance is currently available at this time. Some private companies, such as American International Group, offer insurance policies for China. F. Project Financing Eximbank is also exploring the possibility of implementing a limited recourse project financing program in China. Loans under this program will be available to companies operating investment projects which require imports from the United States. Project financing is also available from the various multilateral financial institutions as described in section C above. G. U.S. Banks in China Scores of national and regional U.S. banks have correspondent banking relationships with Chinese banks. For a list of U.S. banks with representative offices and branches in China, please see Appendix C.