The surge in international bank exposures to China since 2009, fuelled by expectations of renminbi appreciation and internationalization, has transformed the Chinese trade-finance market in to one of the largest globally. But much of this has been carry-trade related: corporates and banks have borrowed in cheap dollars or CNH at a lower rate than renminbi deposit rates on the mainland. Analysts at Citi estimate China received an astonishing $700 billion of hot trade-finance related inflows since 2010, with commodity trade finance representing between 10% and 15% of this.
Bankers have long-feared the trade-finance market is disproportionately large relative to China’s underlying trade. Corporate over-invoicing or outright falsification of transactions, and the channelling of ostensibly trade-related borrowing into higher-spread products – such as China’s $5 trillion shadow-banking market – are key ways in which the mainland’s capital controls have been circumvented.
True to form, on September 25 China’s currency regulator said it had found $10 billion of falsified trade finance transactions, with 15 cases possibly linked to criminal fraud. After a year’s investigation, China claims the practice has now been quashed.
Bankers in Hong Kong are not so sure. The gap between reported Chinese exports to HK and HK imports from the mainland is still large at $7.3 billion, as of mid-August, according to Thomson Reuters Datastream. Still, this is down from the March 2013 peak of $27.8 billion, amid regulatory vigilance and RMB depreciation.
But the supply of trade credits to China will likely remain elevated, given lenders’ appetite, as well as arbitrage opportunities.
DBS, for example, seized on the retrenchment of European lenders between 2010 and 2012 to capture growing portfolio and trade flows from China. It tripled its trade-finance book to S$63 billion ($49.4 billion) in the three years to end-2013, joining HSBC, Citi and Standard Chartered as a leading Asian trade finance house.
Despite the prospect of slowing revenues, transaction bankers are sanguine, citing the quality of their China exposures, which are mostly short-term, collateralized trade credits to state-backed accounts.
But there are broader macro risks. China is now more exposed to the ravages of global sentiment, given the systemically large nature of international bank exposures.
Rising US interest rates, a stronger dollar and commodity price falls – combined with domestic risks, such as tighter trade regulations and the cooling of the shadow-banking market – will create volatility ahead.
In short, trade financing has cloaked speculative flows – but, worryingly, no one knows by how much.