Over-Invoicing China's of Exports Down, Not Out

        By Wayne Arnold
        China's efforts to stop investors from sneaking cash into the country disguised as export earnings has led to a sharp drop in the practice.
        But figures for trade with Hong Kong, via which most of the fake export invoicing happens, shows that it's still happening in a large way. And that implies some investors believe the yuan will resume its upward trajectory at a later point, despite Beijing's successful moves to weaken the currency this year.
        This is how it works. Investors create fake invoices for exports to Hong Kong. That allows them to bring cash back onshore, circumventing China's capital controls, and allowing investors to benefit from higher Chinese interest rates. The extent of the practice is visible in the difference between China's official exports to Hong Kong and Hong Kong's much-lower record of imports from China.
        The gap between China's trade surplus with Hong Kong and Hong Kong's recorded trade deficit with China dropped to $15.7 billion in the first quarter from $46 billion in the same-period a year earlier, the height of over-invoicing, as the practice is called. (Hong Kong's quarterly figures were released last week.)
        China's government cracked down on the practice in May last year. Authorities were concerned the yuan, which has appreciated by over 30% against the U.S. dollar since 2005, had become too much of a one-way bet for investors. A stronger yuan makes China's exports less competitive overseas.
        "A narrower gap between China-HK trade balances suggests that the amount of hot money entering the mainland via over-invoicing exports has been efficiently cracked down during the past few months," said George Xu, an economist at BBVA in Hong Kong.
        China's trade surplus is also shrinking, he noted, meaning lower legitimate exports. Despite that, "foreign reserves continue to grow, suggesting that capital inflows slowed down rather than reversed."
        The People's Bank of China this year has guided the official yuan exchange rate lower, and doubled the range in which the currency can fluctuate. That, combined with slowing economic growth and increasing risk of rising defaults, have soured many bets that the yuan would maintain its stable upward trajectory.
        The dollar has lost 3.4% of its value against the yuan since the start of the year.
        But the large gap -- $15.7 billion -- between trade statistics from China and Hong Kong suggest over-invoicing is still prevalent. Many investors, it seems, still expect the yuan to continue its climb once the central bank has shocked the market into accepting two-way moves can happen.
        The debate over whether the yuan is at a fair market value is getting more heated.
        U.S. Treasury has complained about Beijing's recent moves to push the yuan down as an attempt to gain unfair advantages for Chinese exporters.
        China claims the currency is fairly valued. Some economists are starting to agree, pointing to China's falling trade surplus as evidence.
        Some economists cite a recent measure of China's GDP using purchasing power parity exchange rates to back their case.
        Two economists at the Peterson Institute for International Economics used the PPP data - released last week by a World Bank-linked project - to conclude the yuan is no longer undervalued.
        "This change possibly heralds the end of nearly two decades of China's mercantilist development strategy based on boosting exports by keeping the currency artificially low," the two economists, Martin Kessler and Arvind Subramaniam, wrote in a blog post.
        But the over-invoicing shows that some investors at least see room for the yuan to go higher.
        (END) Dow Jones Newswires

        May 05, 2014 02:31 ET (06:31 GMT)