Steering China on the Road to Capitalism : First Interstate Operation Plays the Middleman in Deals, Financing

In a ceremony at the Great Hall of the People in Beijing last month, the Chinese Olympic team received Visa cards for their trip to Seoul, South Korea, the first credit cards issued to Chinese residents for use outside the country.

The occasion was as good a symbol as any of the creeping capitalism that is making its way into the economy of the world’s most populous nation. It was also representative of the increasing role that American financial organizations are attempting to play in smoothing the way.

For the past several years, American companies have been seeking inroads into the Chinese economy as it moves in fits and starts along the road toward allowing supply and demand to play a role in the marketplace.

One of the most interesting ventures involves Los Angeles-based First Interstate Bank’s merchant banking division, which is believed to be the only U.S. bank operating on mainland China outside the five “special economic zones” along the coast where foreign companies have limited freedom to operate.

While the special zones offer access to China’s cheap labor with minimal bureaucracy and preferential tax treatment, the First Interstate operation is headquartered in Beijing and confronts the complexities and confusion of China’s efforts at economic reform head-on.

American Manager

The 3 1/2-year-old operation is called China International Non-Ferrous Metals Leasing. It is a partnership between First Interstate, Banque Nationale de Paris, Industrial & Commercial Bank of China, Bank of China and the China Non-Ferrous Metals Industry Corp.

The manager is John W. Krafft, 41, a Chinese-speaking First Interstate employee, and the other 20 employees are Chinese nationals. Many of the Chinese are engineers, and Krafft works six days a week along with them.

The company plays the role of middleman between Chinese manufacturers and foreign suppliers, negotiating deals for buying production machinery and similar equipment for Chinese factories and supplying the financing to the Chinese.

The financing is an important element of the equation, according to Krafft, because it allows China to conserve its skimpy foreign exchange reserves. In the past, projects have had to be canceled or delayed because the Chinese lacked the hard currency necessary to finance them.

“The Foreign Trade Ministry says the Chinese plants can’t pay more than 15% down, so we finance the rest over a three-year or four-year period,” Krafft said during an interview at First Interstate’s offices in Los Angeles during a recent vacation here.

He said the financing deals are very straightforward because the Chinese are not ready for the “bells and whistles” of complex financing arrangements. Plus there are no tax considerations in constructing the financing arrangements.

The Chinese factory will pay off the loan out of capital generated by its production, and the Chinese government has insisted that the factories stand on their own in repaying the loans.

Leased Italian Machinery

The Chinese government also has emphasized developing export industries, both to pay for building its industrial base and to generate more foreign currency to continue the development.

For instance, the leasing company recently completed the acquisition of $2 million worth of Italian equipment for a provincial Chinese factory. The machinery is being used to roll aluminum bars into foil for use in cigarette packages and export products.

The creation of an industrial base is viewed by its leaders as critical to China’s development and is the driving force behind the nation’s economic progress.

In June, Deng Xiaoping, China’s leader, predicted that the nation of 1 billion people would be a “middle-developed” country by the year 2050, according to the Economist, a British magazine. That would place it roughly where Ireland and Puerto Rico are today.

The desire to build its industrial base and still conserve hard currency is one reason behind the proliferation of foreign leasing companies in China. While the First Interstate operation is one of only two American leasing companies on the mainland, there are 20 Japanese leasing firms and a number of European ones.

Along with providing financing, the First Interstate leasing company helps represent the Chinese buyers in negotiations with the sellers of the equipment. As a result, Krafft has been on a side of the negotiating table rarely available to foreigners.

“The Chinese are very tough negotiators,” he said. “They were burned in the late 1970s when some foreign companies took advantage of them. So they sometimes overdo the negotiations now. The guy in charge of negotiations for the Chinese risks criticism if he is perceived as giving away too much to foreigners. If he comes back in a week, he knows that they will think he caved in.”

Profit Increasing

As a result, artificial haggling over prices and other elements of a deal can drag out the process, Krafft said.

Nonetheless, the leasing company has been modestly profitable from the start and the profit has increased in recent months, according to Krafft, who has a master’s degree in Chinese studies from the East-West Center in Honolulu and an MBA from Harvard.

“My feeling is that this is an entity that should be profitable,” he said. “At the same time, it has the extra advantage of developing relationships with the Chinese partners. When actual banking comes for U.S. institutions in China, the experience and the relationships will certainly give us a leg up. But that is no longer the primary function.”

Part of the experience involves understanding the Chinese system in which bribes, personal connections and many other behind-the-scenes factors play a significant role in doing business.

“There is always a way to get something done through back channels,” Krafft said. “It’s not illegal. It’s just using the back door.”

Foreigners are still not a fixture on the Chinese scene. Krafft and his wife, Marilyn, live with their two daughters in a modern, three-bedroom apartment in a 15-story building on a compound reserved for foreigners and guarded by Chinese security forces. The building is attached to the Lido Hotel, which is managed by Holiday Inn, another touch of capitalism in mainland China.