CNH Tracker-Record surge in yuan trade may mask a darker truth
By Michelle Chen HONG KONG, Feb 6 (Reuters) - The record surge in cross-border yuan trade settlement may be glossing over an uncomfortable truth -- arbitrage fund flows that seem to point to other factors at play. Arbitrage fund flows have been taking advantage of juicy yields in the onshore market, and the trend is expected to sustain given the chunky gap between the onshore and the offshore yuan market rates. The strong pickup in trade is partly due to a robust and stable currency, which has led more foreign trading partners to adopt the currency in their trade settlement systems. Still, market players say there is a murkier side to this. Bankers say some exporters and importers may have again taken advantage of the different foreign exchange rates of the yuan as well as interest rates in China and Hong Kong to lock in profits via trade channels. Fake invoices, value-inflated trade and arbitrage fund flows in the disguise of trade transactions were also likely key factors pushing up the yuan trade. Trade settlement handled by Hong Kong banks increased 78 percent to 469.6 billion yuan ($77.49 billion) in December from a year earlier, its highest since the scheme was launched nearly five years ago, according to the latest statistics from the Hong Kong Monetary authority (HKMA). Round-tripping remains strong as Hong Kong's re-exports to the mainland, which originated from the mainland, represents nearly 50 percent of the city's total exports to China, ANZ said in a report. "The round-tripping trade has become an avenue to fuel China's capital inflows. The current accounts could have been improperly used as an alternative way of liquidity injection," said ANZ analysts. A recent study by research group Global Financial Integrity (GFI) revealed that $400 billion had flowed illicitly into China from Hong Kong via trade misinvoicing between 2006 and the first quarter of 2013. The suspected arbitrage flows contributed to the heavy capital inflows to the world's second-largest economy, pressuring the Chinese currency higher and challenging the government's efforts to tackle volatile flows. Fund inflows to China may have then made their way into bonds, stocks and wealth management products which provide more attractive returns than their counterparts in overseas markets. The HKMA told Reuters it had no comment on the yuan trade figure. Beijing still keeps a tight leash over its capital accounts and it is difficult for foreign investors to tap onshore markets except by way of some pilot schemes such as Qualified Foreign Institutional Investor (QFII) and Renminbi QFII. Investors' appetite in yuan assets was reflected in the enthusiastic subscription to an RQFII product in January when a Chinese money manager had to apply for new quota only two weeks after it listed the first RQFII ETF in London. The yield level in China and overseas markets has been kept wide for some time. China's 10-year government bonds are quoted at 4.55 percent, while the U.S. treasury bonds with the same tenor yield at 2.66 percent. A firmer yuan and higher interest rates could attract more money inflows this year, and Beijing is considering a "Tobin tax" on financial transactions to deter speculative capital flows, an official at the State Administration of Foreign Exchange (SAFE) said in January. China's foreign exchange reserves, the world's largest, rose $157 billion in the fourth quarter to $3.82 trillion at end-2013. WEEK IN REVIEW: * E Fund Management (Hong Kong) said it was going to launch an exchange-traded fund (ETF) tracking Citi Chinese Government Bond 5-10 Years Index in early February. As of end-2013, the yield to maturity for the index was 4.588 percent, according to Citigroup Index LLC. * Yuan deposits in Hong Kong rose to 860.5 billion yuan ($142.11 billion) in December, up 4.0 percent from a month earlier, said the Hong Kong Monetary Authority. Cross-border trade settled in yuan increased 6.9 percent to 469.6 billion yuan on a month-on-month basis. * Growth in China's services sector slowed to a five-year low in January, an official survey showed, another sign of stuttering momentum in the world's second-largest economy that could deepen investors' concerns about emerging markets around the world. CHART OF THE WEEK: RMB cross-border trade settlement handled by banks in Hong Kong hit record high in December:RECENT STORIES: CNH Tracker-China must chop down regulatory thicket to woo investors ANALYSIS-China's yuan carry trade, an anchor and a risk for Asia More stories about the CNH market Daily onshore yuan reports Daily China money market reports Offshore yuan rate Onshore yuan rate Offshore yuan dealt Onshore yuan on CFETS THOMSON REUTERS SPEED GUIDES
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