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RR RUEHCN RUEHGH
DE RUEHGH #0015/01 0200800
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R 200800Z JAN 10
FM AMCONSUL SHANGHAI
TO RUEHC/SECSTATE WASHDC 8475
INFO RUEHBJ/AMEMBASSY BEIJING 3242
RUEHCN/AMCONSUL CHENGDU 2335
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUEHGZ/AMCONSUL GUANGZHOU 0792
RUEHHK/AMCONSUL HONG KONG 2506
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RUEHML/AMEMBASSY MANILA 0145
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RUEHFR/AMEMBASSY PARIS 0036
RUEHUL/AMEMBASSY SEOUL 0641
RUEHSH/AMCONSUL SHENYANG 2326
RUEHGP/AMEMBASSY SINGAPORE 0309
RUEHIN/AIT TAIPEI 2124
RUEHKO/AMEMBASSY TOKYO 0852
RUEHUM/AMEMBASSY ULAANBAATAR 0015
RUEHGH/AMCONSUL SHANGHAI 9141

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. 
 
======================================= 
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. 
 
======= 
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