China’s Hot Money Headache

“The accelerating export growth might be mainly a result of an improved global economy,” wrote Bank of America Merrill Lynch’s Ting Lu and Sylvia Sheng in a note to clients. “But we are concerned that a rising (yuan) and rising bond yields could once again entice capital inflows via over-reporting of exports.”

Whatever the mechanism, the goal is the same – to borrow abroad at rock bottom rates, and put the cash in high-yielding Chinese investments. While experts debate the pros and cons of lifting China’s capital controls, they are looking increasingly porous.

China’s regulators are trying to get on top of the situation. The State Administration of Foreign Exchange said on Saturday it would tighten the supervision of cross-border financing. The body called on banks to step up their auditing and report suspicious borrowing, especially long-term trade financing. The agency also reiterated that companies must have legitimate trade-related reasons for exchanging foreign currency, and that there are tough penalties for breaking the rules.