Beijing’s Ten Commandments Against “Finance-Motivated Trade”

It is beyond dispute that State-Owned Enterprises (SOEs) in China have privileged access to formal financing such as bank loans. And it is also a basic fact that SOEs are not the most efficient producers of goods or services, especially in terms of short-term measurements.

Against the backdrop of this basic reality, the puzzle is: How have private enterprises made outsized contributions to the spectacular growth in China notwithstanding their limited access to formal financing? Economists tend to think informal finance by way of trade credit explains how Chinese private enterprises indirectly get credit for expansion.

In October 2023, the State-owned Assets Supervision and Administration Commission of the State Council (SASAC) issued the Circular on Regulating Central SOEs’ Trade Management and Strictly Prohibiting All Kinds of Fake Trade Transactions, which is commonly known as Document 74.

In 2013, regulators had not yet called out fake trade. Instead, SASAC warned central SOEs to stay away from finance-motivated trading activities in the realm of commodities. 融资性贸易 emerged as newly coined lingo, which can be directly translated as “financing trade”. But it would be difficult to linguistically distinguish legitimate “trade finance” from this troublesome “financing trade”.

For normal trade finance, credit is an instrument that facilitates trading. For finance-motivated trade, trading is the façade of lending. “Façade” is a matter of degree. In some cases there is no real underlying commercial reality whatsoever other than using contracts as cover for the movement of funds. This would be the prototypical fake trade which is in essence stealing from the state coffer, punishable by jail terms.

Putting aside outright fraud which is outlawed anyway, why is lending by central SOEs a problem to be rectified?

Many private enterprises are in great need of credit to operate or expand while formal financing is very restricted. Even though central SOEs may be highly privileged in terms of their own access to credit, they cannot openly lend to unrelated entities except for those SOEs which are financial institutions themselves.

In the last decade, several structural changes led to a greater demand for credit by way of legally dubious finance-motivated trade with SOEs. On the one hand, managers of SOEs are under increasingly elaborate KPI-based evaluation. If these managers want to keep their jobs and get promoted, the SOEs under their management need to maintain certain growth, at least on the books if not in real terms. Trading is the easiest way to produce growth on the books while earning interest on the credit extended.

On the other hand, Beijing’s efforts to deleverage local government finance translates into a liquidity squeeze. Various forms of shadow banking became no longer viable. Additionally, the US trade war with China since 2018 only further worsened the situation.