Tainted Bonds

Whole Earth, Spring, 1998 by Catherine Caufield

AMERICAN UNDERWRITERS UNDERMINE US GOVERNMENT POLICY, CHINESE LIVES, AND ENVIRONMENTAL REASON

Screened bond funds, such as Calvert Social Bond, screen corporate bonds as they do stocks and only buy government bonds for programs they support (student loans, hospital construction, etc.). We know of no screened global bond funds. Warning! Unbeknownst to members, pension funds and others may buy bonds that conceal their real purposes. Here is one story.

President Jiang Zemin, fresh from his triumphant late-1997 visit to the United States, presided over a ceremony marking the end of the first phase of what, if successful, will be an even greater triumph, the construction of the Three Gorges Dam. With the brass band of China's Naval engineering institute playing "Song for the Motherland," the Yangtze River was diverted by a temporary dam into a side channel, enabling construction of the main dam to begin.

Environmentalists, human rights activists, and dissident engineers have so successfully raised questions about the dam's technical, social, environmental, and economic feasibility that even those old dam backers, the World Bank, the US Export-Import Bank, Bechtel Corporation, the Tennessee Valley Authority, and Hydro-Quebec are giving it a wide berth.

Foreign financing for the dam is being channeled through the State Development Bank, created in 1994 specifically to fund the Three Gorges dam and other large politically motivated projects. One Wall Street China analyst describes these so-called "policy projects" as "poorly planned" and "unlikely to recoup their cost." Institutional Investor calls it "the chanciest China play there is."

The government insists that it will be self-financing by 2005 and that all the debt will be repaid by 2012. Such a rapid pay-back would be unprecedented in the world of big dams. It is a rare thing for a dam simply to meet its cost and time projections. China's largest hydro-dam so far, the Gezhouba, which is just downstream of the Three Gorges, took nineteen years to build and cost $625 million, rather than the promised five years and $168 million. The same company that built the Gezhouba is building the Three Gorges dam.

Despite the impressive analysis and advocacy questioning the dam's cost/benefits, the State Development Bank sold more than $200 million of bonds in Japan in March 1996. A planned second offering was suspended, however, after Kazou Sumi, professor of International Law at Niigata National University, charged that the first bond issue violated Japanese security laws by failing to provide clear information on the use and risks of the bonds. In January of 1997, Lehman Brothers, Smith Barney, Inc., J.P. Morgan, Morgan Stanley & Company, Inc., and BancAmerica Securities, Inc. joined Credit Suisse First Boston in underwriting a $330 million bond issue in the US and Europe.

Critics of the dam say it is a dead weight on the Chinese economy and the government's determination to continue with it will undermine investor confidence in the country. Similar politically motivated megaprojects, such as the Bakun dam in Malaysia, have been important factors in the investor retreat from other Asian countries. "China's policy projects and the policy banks set up to fund them expose an awful lot of what is wrong with China," says Mark Mansley of Delphi International in London. "Their justification is political, not economic." Despite the talk of China's move to a free market, China's rulers still exercise a great deal of control over the economy. Three Gorges is just one example of political domination of the market, says another analyst at one of the other ratings agencies. "China is going down the same road of excessive property values, bulging external debts, and government interference with the market that has brought down so many of its neighbors. I think there's a false sense of security there. The question is, is China too big to fall?"

INDIRECT FINANCING

It might seem that copious bad publicity about the dam's social and environmental problems and its questionable financial feasibility would scare off foreign investors. That this has not been the case is largely due to indirect financing. Investors who would shy away from a high-risk project are happy to lend money to the state-owned bank that finances it. This arm's-length deal protects the investor from his real investment. In the case of the Three Gorges, investors can be reasonably confident that the people of China will pay for the dam, whether or not the dam pays for itself. Though deploring its "severe assets quality problems," Moody's Investors Service gave the bank an A3 rating because it believes that China's rulers are so closely identified with it that they would lose face if it defaulted.

Another feature of indirect financing is that investments are funneled through an institution that funds several projects, thus enabling investors and underwriters to deny, however improbably, involvement in any individual project. The Bank of America, one of the six underwriters for the American bonds, actually maintains that none of its share of the bond issue will be spent on Three Gorges.