HOT MONEY INFLOW RESTRICTIONS BEING IMPLEMENTED IN EAST

UNCLAS SECTION 01 OF 03 SHANGHAI 000015

SENSITIVE
SIPDIS

DEPT FOR EAP/CM
NSC FOR MEDEIROS, LOI, SHRIER
STATE PASS USTR FOR STRATFORD/WINTER/MCCARTIN/KATZ/MAIN
USDOC FOR ITA DAS KASOFF, MELCHER, SZYMANSKI, MAC/OCEA
TREASURY FOR OASIA/INA -- DOHNER/HAARSAGER/WINSHIP
TREASURY FOR IMFP -- SOBEL/CUSHMAN
STATE PASS CEA FOR BLOCK
STATE PASS CFTC FOR OIA/GORLICK
MANILA FOR ADB USED
PARIS FOR US/OECD

E.O. 12958: N/A
TAGS: ECON EFIN EINV PGOV CH MG
SUBJECT: HOT MONEY INFLOW RESTRICTIONS BEING IMPLEMENTED IN EAST
CHINA


1. (SBU) Summary: Manipulation of trade transactions across
China's borders to arbitrage anticipated renminbi movements has
decreased under a new trade-transaction verification system.
However, investors can still get "hot money" funds into China
through a variety of loopholes -- such as transactions using
Mongolian banks -- and demand has been picking up as the market
prices in 2-3.5 percent renminbi appreciation in 2010. On a
separate note, U.S. importers are not welcoming a Chinese
program encouraging their use of renminbi for settlement of
trade payments. End Summary.

==========
Background
==========


2. (SBU) Visiting Federal Reserve Bank of New York Senior Vice
President John Clark, International Officer Hunter Clark, and
Senior Financial/Economic Analyst Jeffrey Dawson met with
Wachovia Shanghai Branch Managing Director and General Manager
Benjamin Kinnas and Vice President Han Lin on Thursday, December

10. Wachovia is a major correspondent bank for Chinese
counterparties, and provides export financing; the bank is
involved in transactions associated with around 10 percent of
China's total trade, according to Kinnas.

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Hot Money Flows Face More Hurdles . . .
=======================================


3. (SBU) Wachovia's Kinnas explained that the August 2008
regulations issued by SAFE have given Chinese authorities an
effective tool for controlling "hot money" inflows -- capital
that investors take into the country for short-term arbitrage on
exchange rates or interest rates. Lin said that the regulations
have plugged the loophole through which discrepancies in trade
invoicing were used to transfer foreign capital into China
through the trade account; inflows of capital under the capital
account continue to be tightly restricted. (Note: China allows
free conversion of foreign currency into renminbi, provided the
foreign exchange is earnings from exports. Prior to the new
system, firms could agree with overseas traders to artificially
hike the value of exports -- "over-invoice" -- and use the
excess trade "earnings" in China for investment or to speculate
on renminbi appreciation. End note.)


4. (SBU) The 2008 regulations require banks to hold in escrow
any foreign currency deposited by an exporting company into its
bank account until the earnings are validated as coming from
legitimate export transactions. After putting the funds in
escrow, a bank must log into a General Administration of Customs
database to confirm that the firm has legally registered exports
valued at or above the value of the foreign currency deposit;
the bank will then note in the Customs database the amount of
foreign currency being deposited, and Customs will subsequently
subtract this amount from the total. (Note: Kinnas commented
that the new requirements have required him to staff an
export-transaction verification desk. The added operating costs
are not exorbitant, but this mandate is an example of how
Chinese authorities are starting to push policy compliance
monitoring responsibility onto firms. End note.)

===============================
. . . But Can Still Get Through
===============================

SHANGHAI 00000015 002 OF 003




5. (SBU) Loopholes remain in the system that allow investors to
avoid the US$50,000 per person, per year limit on foreign
exchange conversion, said Kinnas. One favorite legal route is
transferring money through Mongolia. Under a bilateral trade
agreement between China and Mongolia, an unlimited amount of
dollars can be converted into renminbi in Mongolian banks. One
need only open a dollar account in a Mongolian bank, transfer in
dollars, convert these into renminbi, and then transfer the
renminbi to a Chinese bank, said Kinnas.


6. (SBU) In another legal channel, people can convert foreign
exchange into renminbi in the overseas branches of the two
Chinese banks that have offshore conversion licenses -- Bank of
China and Industrial and Commercial Bank of China. For example,
it is possible to use an "overseas remittance program" in the
Bank of China New York Branch, although there is a limit of
US$50,000 per transaction and the bank "gouges" remitters on the
exchange rate, according to Kinnas.


7. (SBU) More in the grey area, said Kinnas, some investors use
family and friends to make multiple transfers of US$50,000.
Kinnas also hinted that Bank of China managers can be paid
bribes to facilitate illegal foreign currency transfers.

============================================= ==================
Renminbi Appreciation Expectations Reflected in "Trade Finance"
============================================= ==================


8. (SBU) Through summer 2008, market anticipation of renminbi
appreciation was reflected in high demand in China for borrowing
renminbi against future earnings of dollars, said Kinnas.
Typically borrowed in 180-day increments, this was officially
labeled trade financing. When renminbi appreciation
expectations evaporated with China's falling export outlook
following the fourth quarter of 2008, this "trade financing"
also fell off. As a result, it created the appearance that the
fall in trade financing was greater than the fall in trade.
With the market anticipating a 2-3.5 percent renminbi
appreciation in 2010, said Kinnas, China-based companies are
again approaching Wachovia to set up similar financing
arrangements.

============================================= ===
An Experiment: Are Bank Transfer Rules Enforced?
============================================= ===


9. (SBU) SAFE is using technology to better control foreign
currency transfers under the capital account, said Lin,
illustrating his point with an experiment he undertook. He
transferred from overseas three US dollar amounts to accounts he
opened in his name in three Chinese banks: to a Bank of China
branch, he wired US$25,000; to another of China's major banks,
he wired US$24,000; and to a small city-level bank, he wired
$2,000. He then attempted to convert the US dollars into
renminbi in each of the banks. He successfully converted the
first two amounts, but when he applied to convert the last
US$2,000, the local bank informed him that he would only be able
to convert US$1,000. They were aware that this was his limit,
the bank staff told him, by consulting his foreign exchange
records using a special computer terminal provided by SAFE.

=====================================
RMB Internationalization Going Slowly

SHANGHAI 00000015 003.2 OF 003


=====================================


10. (SBU) Few of Wachovia's trade finance customers are moving
toward using renminbi to settle payment of trade transactions,
said Kinnas. There are two reasons. First, a company importing
from China that agrees to pay in renminbi essentially takes on
foreign exchange risk from the Chinese exporter. When foreign
companies take on such risk, they often look to offset it with a
foreign currency derivative, locking in their expenses and
revenues. However, there is no liquid, transparent market for
Chinese renminbi forwards or exchange rate swaps. Second, the
system for settling trade payments in renminbi is not
user-friendly -- only certain banks and specific companies have
been designated as part of the pilot. In addition, Wachovia
offers additional services, such as trade finance, in addition
to its currency clearing business, so customers get one-stop
shopping.


11. (SBU) Outside China, Chinese banks are contacting branches
of non-Chinese banks to pressure them to open offshore renminbi
accounts, apparently in response to a mandate from the People's
Bank of China (PBOC),said Lin. The Chinese banks are not
concerned if the foreign banks have renminbi to deposit in the
accounts, and appear focused only on increasing the numbers of
the accounts. In some cases, a Chinese bank has suggested that
opening an offshore renminbi account will give that Chinese bank
"face," and therefore will facilitate the foreign bank's
long-term business operations in China.

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Comment
=======


12. (SBU) From the East China perspective, China's leaders are
still fighting an uphill battle to control foreign exchange
inflows into China, despite more adept use of technology to
monitor transactions. Because many local governments are
desperate to see a turnaround in exports -- and the jobs and
revenue that exports bring -- there is little motivation on a
local level to strictly monitor foreign exchange inflows that
are nominally tied to trade, even if some are falsifying trade
records to import funds. In turn, these foreign currency
inflows, to the extent that they outrun the PBOC's sterilization
efforts, will contribute to inflation that banking and finance
officials increasingly cite as their primary concern in 2010.
Efforts to internationalize the renminbi, which could eventually
lead to lower foreign exchange reserves buildups, do not appear
to be making much headway at present.


13. (SBU) The Federal Reserve Bank of New York has cleared on
this cable.CAMP