Traders who intentionally buy goods abroad, import them, and then sell them at a loss don’t usually stay in business for long. So when earlier this year some Chinese traders did just that – importing copper purchased on the London Metal Exchange (LME) for higher than the Shanghai spot price – more than a few eyebrows were raised.
The phenomenon has little to do with actual demand for copper – in the sense of using the material – and more to do with China’s tight credit markets.
Since last year, the country’s banking regulators have slowly but surely tightened restrictions on how many loans banks can dole out. This practice hurts small businesses more than most, because with only a limited supply of credit to ration, most banks prefer lending to safer state-backed companies.
In response, many small, private Chinese companies have turned to non-bank lenders. In turn, informal lending rates have been pushed upward. According to Credit Suisse, this “Wenzhou” lending rate has risen to about 5% per month in June 2011, up from just 1.5% in early fall 2010.
What’s a cash-strapped small business owner to do? One solution is to import copper.
The logic works as follows. Letters of credit are issued by banks to traders who purchase goods abroad for import. While bank loans are expensive and difficult to come by in China, obtaining a letter of credit remains fairly cheap and easy.
Whereas traders normally use letters of credit to obtain copper, in China traders use copper to obtain letters of credit. If the price in Shanghai is higher than what it costs to buy copper abroad – plus transportation fees and import duties – the trader can sell at a profit and still have access to bank financing until the letter expires, usually three to nine months later.
In recent months, however, the price of copper in China’s home market has risen above the global price. Yet many still reckon that the loss is worth access to bank financing – hence the oddity of traders buying copper abroad, knowing full well that they will lose money on the import.
No one denies that the practice does occur. “Definitely there’s been some import financing,” said Max Layton, a London-based analyst with Macquarie Securities. “What’s difficult is to quantify is exactly how much.”
End of the party
Analysts are divided on this point. While acknowledging that bonded stocks of copper did rise in the first quarter of 2011, Layton hesitates to attribute the rise solely to import-for-financing schemes. “We don’t see any evidence that import financing was massive,” said Layton.
He adds that while the tight credit market may have caused some distortions in the copper market, the practice cannot continue forever – eventually traders will sell back to international markets. “China, in the face of very high prices, is doing what it did in 2005, 2006 and 2007: De-stocking every last ton of available metal in the country,” he said.
Others reckon the scale of import-for-financing was far larger. “In the first four months of the year, I would say around 50% of [copper] imports [were for import-for-financing],”said Judy Zhu, a commodities analyst at Standard Chartered. “The on-the-ground perception is that the financing is still going on, and that people are still quite short of working capital because the overall monetary tightening policy.”
However, Zhu cautions that the phenomenon is temporary, and may end soon. On April 1, the China Banking and Regulatory Commission introduced new rules designed specifically to cut down on the copper import-for-financing channel.
While existing schemes are still in play, new starts have dropped sharply. Net copper imports for April were down 40% to 110,000 tons, compared to over 300,000 tons per month in the second quarter of 2010.
Still, Zhu reckons the schemes will continue, albeit at a lower base. “It will be much harder than before to start new deals,” she said. “But as long as there is demand in the market, people will find a way out to continue their business.”