China Wrestles With Hot Money--from Locals

Chinese officials are stepping up their efforts to regain control of the money markets and currency. The main target does not appear to be foreign investors, but rather the behavior of domestic businesses. Over the past weekend, China's foreign exchange regulator announced new rules designed to limit the banking system's ability to short foreign currencies and increase exposure to the yuan.

According to data posted by the PBOC, as of the end of March, Chinese banks had the equivalent of $441.6 bln of foreign currency deposits, but had foreign currency loans of $754.3 bln. This mismatch is problematic in terms of the risk-management of Chinese banks and in terms of contributing to the appreciation of the yuan.

The PBOC met with primary dealers today after the local market closed. Reports indicate that the PBOC queried about the demand for 3-month bills, which appears to be the popular vehicle to absorb short-term "hot" money. After the meeting, the PBOC announced that it will sell CNY10 bln 3-month bills on Thursday. The sale of bills to mop up excess liquidity has not been used for the better part of the year and a half.  It may presage larger drains of longer-term funds. 

Another domestic source hot money coming into the country appears to be from the trading companies.  Suspicions are running high that some Chinese companies may be exaggerating exports into order to repatriate more money back into China, ostensibly betting on yuan appreciation.  Over-invoicing for exports is understood to be a common way Chinese businesses circumvent the capital controls. 

March and April exports be reported much higher than expected.  The existence of two extra working days in April is not a very satisfying answer.  In particular, exports to Hong Kong and other bonded trade areas, do not mesh with other trade data.  China reports, for example, that April exports to Taiwan are up more than 49% year-over-year.  Taiwan's figures show imports from China are down 2.7% year-over-year in April.   

China reported its exports to Hong Kong rose 57.2% year-over-year.  While Hong Kong has yet to report April trade figures, given that Hong Kong re-exports those imports, and the weakness in the US, Japan and euro area, the China's estimate seem too much.  Additionally, a 40-day port workers strike at Hong Kong's container port just ended this week and that would have been expected to slow imports.  Moreover, the export order component of the manufacturing PMI has fallen in three of the four months this year. 

Some investment banks are estimating that as much as 2/3 of the 14.7% year-over-year rise in April exports, reported earlier today, are fictitious.  Chinese officials have indicated earlier this week that it will be closely watching cross-border flows  by importers and exporters.  This could result in a moderation of export growth in the period ahead.   The yuan has appreciated 1.45% against the US dollar thus far this year and has recently been stronger than we expected.    While it has not a very large move in the world of foreign exchange, we suspect that officials will seek to engineer a more stable tone.