Chinese companies are now accumulating as much US dollar as possible7 July, 2012, 18:46. Posted by Zarathustra
Last week, we brought your attention to the rapid increase of foreign currencies deposits in China since late last/early this year. The increase of foreign currencies deposits came largely from non-financial enterprises according to statistics from the Peoples’ Bank of China. This, we speculated, reflects the fact that Chinese Yuan is now depreciating and is expected to depreciate in the near future, such that companies prefer holding US dollar.
That is an interesting turn of the trend. In the past, many companies which trade with the rest of the world would convert US dollar they got from trade settlement into Chinese Yuan as much as practicable. In fact, they seemed to have converted more than they had to according to Standard Chartered, leading to the curious conclusion that corporate China as a whole was short the US dollar.
Today, Economic observer reports that trading companies are now less willing to convert the US dollar into Chinese Yuan. In fact, they are now trying to accumulate as much US dollar as possible because the US dollar is now strengthening as we expected, and only bought just enough Chinese Yuan for their operation. This new trend emerged since late last year. Not only that, the report also confirms what Standard Chartered told us: many of these companies were short US dollar.
|Source: Mattes via wikicommons|
How the shorts arose? According to Economic observer, when Chinese Yuan was strengthening, instead of buying US dollar (while selling Chinese Yuan) to pay for imports, many companies simply borrow US dollar from banks to pay for imports, effectively shorting US dollar. This was good for them because US dollar was weakening, thus their US dollar-liabilities fell in CNY term. Of course, as the reverse is now happening, these companies have to cover the short position.
This reminds us of a story from FT beyondbrics, which told us what some Chinese companies have been doing with USD and CNY: interest arbitrage (sort of) disguised as trade finance:
One of the main types of arbitrage works as follows. A Chinese company places renminbi on deposit with a mainland bank, earning an interest rate of about 3.5 per cent. The company then obtains a long-dated, renminbi-denominated letter of credit from the bank, ostensibly to pay for a shipment of goods from its own subsidiary in Hong Kong.
In turn, the Hong Kong subsidiary takes the letter of credit to a local bank and uses it as collateral to obtain a US dollar loan at a lower interest rate than those available on the mainland. In many cases, the company would also use a currency derivative to eliminate the foreign exchange risk. The end result: the company has captured the difference between onshore and offshore interest rates, less banker’s fees.
The fact that traders are holding onto US dollar for longer have implications for monetary condition within China, as inflows (regardless of how they arise) to China force the central bank to intervene by essentially printing money, creating CNY liquidity within the banking system. As trade surplus trending lower, traders less willing to convert all the trade surplus into CNY, and capital inflow slows , there is less need for foreign exchange intervention, thus less money would be created (if not outright being destroyed). As a result, China is caught in an curious situation where the domestic economy needs even easier monetary condition (at least the government probably wants that now) but flows are leading monetary condition in an opposite direction.