Companies gambling on yuan appreciation are distorting Chinese trade statistics, creating a monetary policy headache for Beijing officials and complicating government plans to liberalize the capital account.
Speculative inflows disguised as trade are causing concern because they aggravate a recent trend - the sudden resurgence of hot money inflows. Some $125 billion poured into China in January and February after nine consecutive months of outflows, exclusive of hot money masquerading as trade.
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Companies that cannot legally move money into the country for the purpose of currency speculation often try to circumvent China's capital controls by overstating trade invoices, thereby disguising investment funds as payments for goods and services sold overseas, according to economists.
These firms are betting on an extended rally of China's currency, which has gained more than 3 percent against the dollar since the third quarter of 2012 to hit a record high on Friday morning. Now that is even distorting trade data.
To keep the exchange rate from appreciating too quickly in the face of such bullishness, the People's Bank of China (PBOC) has stepped up its meddling in the domestic forex market, despite repeated public promises from regulators to stay on the sidelines.
This intervention has caused Chinese foreign exchange reserves to rise by over $128 billion in the first quarter of 2013, compared with $130 billion for all of 2012, by extension pouring a tide of yuan into China's interbank market and applying downward pressure to short-term interest rates.
The central bank, aiming to keep rates under control, has been forced to adapt the way it manages liquidity, which has rattled the country's equity and money markets.
"If this trend is sustained, it complicates monetary policy; it adds liquidity to the economy which then inflates money and credit growth and property," said Robert Subbaraman, economist at Nomura in Hong Kong.
"The risks are that it might get authorities to think twice about how fast they open up the capital account."
Official trade data on Wednesday showed that China's exports grew by an annual 10 percent in March, appearing to stabilize after two months of strong performance, but economists were quick to question the credibility of the figures.
"Compared to the rest of Asia, China stood out like a sore thumb," said Subbaraman. He said that while East Asian countries' exports usually rise and fall at similar rates, in recent months China's 10 percent annual growth rate far exceeded neighbors such as Taiwan (3.3 percent) and South Korea (0.3 percent).
Most skeptics took particular note of the apparent explosive growth (over 90 percent) in exports to Hong Kong and 300-plus percent growth to bonded customs zones, despite the fact that export demand from the United States and Europe - ordinarily the ultimate destination for such exports - remained tepid.
Statistics from Hong Kong and Chinese customs have also fallen out of sync, with Chinese customs reporting more exports to Hong Kong than Hong Kong customs is reporting imports from China. (See graphic: http://link.reuters.com/beg37t)
Lu Ting, economist at Bank of America-Merrill Lynch, pointed out in a research note distributed to clients that the growth of exports in high-value integrated circuits was particularly suspicious since such products are cheap to ship and their value is "easily manipulated".
"There are no exogenous factors that help to explain why the fluctuations have been so large in China-Hong Kong trade in February and March," said Fredrik Erixon, director of the European Centre for International Political Economy, a think-tank in Brussels.
"The transactions between China and Hong Kong are just the symptom of a larger problem."
Zheng Yuesheng, spokesman of China's General Administration of Customs, said officials were investigating "abnormal trade growth with Hong Kong" and would take regulatory steps if needed.
What those measures might be is an open question.
Historically, regulators have struggled to prevent the opening of China's capital account from becoming a channel for exchange rate speculation. Destabilizing speculative flows would put China's macroeconomic stability at risk and discourage the increased usage of the yuan in trade, a key policy goal.
"If RMB is accepted in international transactions due to reasons which are not related with speculation and arbitrage, the internationalization of the RMB should be welcome," said Yu Yongding, an economist at the China Academy of Social Sciences, in an email to Reuters.
"Otherwise, the internationalization is false, is something else, and is not sustainable. As soon as expectations change, unwinding will begin."
In Hong Kong, offshore yuan (CNH) continues to trade at a premium to the onshore spot market, implying offshore investors expect it to keep rising. But dealers in China's interbank market question the sustainability of those expectations, given the country's economic recovery remains tenuous, being very dependent on a sustained recovery in genuine export demand.
Several money dealers in Shanghai, who spoke on condition of anonymity because they are not authorized to speak to the media, told Reuters they are already seeing signs that speculative inflows are slowing.
"The more money can come in, the more it can go out as well," said Subbaraman of Nomura.
"If China slows down more than people expect, it could cause capital flight."
(Additional reporting by Robin Emmott in BRUSSELS; Editing by Ken Wills)