Beijing guides renminbi lower in effort to manage financial risks

http://www.ft.com/intl/cms/s/0/ba53bbb2-9f9a-11e3-b6c7-00144feab7de.html?siteedition=intl#axzz2uZRXvU6H

2014.02.28 By James Kynge

In guiding the renminbi into its steepest dive since 2005 this week, Beijing was employing a strategy of “one arrow, two vultures”, as the saying goes.

The first vulture denotes the international speculators who have – in spite of warnings by Chinese officials – regarded renminbi appreciation against the US dollar as a one-way bet. The second vulture signifies the domestic shadow financiers who refuse to be brought down to earth.

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A shadow banker in Ningbo, eastern China, recently described the attractions of such a trade. “It is easy to borrow abroad at around 1 per cent annual interest. Then change that money into renminbi and bring it into the mainland,” said the banker, who declined to be identified because of the illegal nature of his business.

“You can get around 10 to 12 per cent by lending it to a trust or around 20 per cent by putting it with an underground bank. On top of that you get whatever the renminbi has appreciated by the time you need to repay the foreign loan.”

One sign that this cross-border carry trade has been robust of late is evidence of an increase in the over-invoicing of exports, a common ruse used to spirit funds into the mainland. A China Confidential survey of exporters in January found that 44 per cent of respondents thought that such fake invoicing was on the increase.

Besieged by these pressures, it is hardly surprising that the PBoC was keen to shoot an arrow. Its hope is that by instilling in speculators’ consciousness a sense that the renminbi can fall as well as rise, it will staunch the inrush of speculative capital lured by the outsized returns available in the mainland’s shadow finance markets.

In this, as ever, Beijing is looking for incremental shifts, such as the 1.2 per cent that the renminbi has depreciated by so far this year. It knows that if it were to try to stop the inflow of illegal capital entirely, it may trigger the very wave of financial defaults it is hoping to avoid. Thus a gradual approach using exchange rate flexibility to generate a market response seems to suit the PBoC’s objectives for now.