HK$146 billion hole reveals Shenzhen's illicit carry trade
Exporters are hugely overstating trade figures to take advantage of low interest rates in Hong Kong and invest borrowed money on the mainland
On Monday the Hong Kong government's Census and Statistics Department published trade numbers showing that in April the city imported HK$160 billion worth of stuff from the mainland.
"Big deal", you are probably thinking. "That has got to be the world's least interesting piece of information."
And you'd be right, except for one thing. A couple of weeks earlier China's General Administration of Customs released its own data, showing that the mainland's exports to Hong Kong in the same month were worth HK$306 billion - almost twice as much.
So according to official figures, goods worth HK$306 billion left Shenzhen on their way to Hong Kong, but only HK$160 billion worth of stuff actually arrived here.
Clearly something is wrong. In theory the numbers should match. Normally there is some discrepancy; typically around HK$10 billion a month. But as the first chart below shows, in recent months the gap has blown out to a whole new level.
Altogether over the last six months, the mainland exported HK$726 billion more stuff to Hong Kong than Hong Kong imported from the mainland.
What's happening is that mainland companies are massively overstating the value of their export shipments to take advantage of a profitable interest-rate carry trade.
With US dollar interest rates just a whisker above zero, and benchmark Chinese rates at a little over 3 per cent, the differential is big enough to generate an attractive arbitrage opportunity.
According to Cliff Tan, head of global markets research at Bank of Tokyo-Mitsubishi, last month a simple US dollar-yuan carry trade would have earned a return of 0.27 per cent.
That might not sound a lot, but it equates to an annual return of 3.3 per cent; not bad in an era of low yields.
In reality the actual returns can be much higher. Dong Tao, managing director at Credit Suisse, explains that mainland companies exaggerate the size of their export shipments in order to obtain letters of guarantee from their onshore banks.
They then use these letters of guarantee to take out foreign currency loans in Hong Kong, converting the proceeds into yuan, which they ship back to the mainland to invest in wealth management products in the shadow banking market.
With these wealth management products typically promising returns in high single digits, Tao estimates that the yield spread earned by the carry trade can be as much as 5 percentage points, with exchange rate gains from any appreciation of the yuan an added bonus.
On top of that, exporters can boost their returns by increasing their leverage. In fact, they don't actually need to export their goods at all. They can move the same shipments repeatedly into and out of bonded trade areas on the mainland, getting a new letter of guarantee, and a new loan, each time.
It's proving a popular trade. As the second chart shows, over recent months reported exports through bonded trade areas in Shenzhen have soared in value.
It's likely these phantom shipments have exaggerated the overall health of China's export sector. According to Credit Suisse's estimates, the actual growth rate of the mainland's exports over the first four months of this year was somewhere between 2 and 5 per cent, not the 17 per cent official figures indicate.
Yuan carry trades have also fuelled the explosive growth of China's shadow banking system, and the mainland market in high-yield wealth management products, which expanded by more than 50 per cent last year.
And they have made monetary policy a lot more difficult to manage. But as the HK$146 billion discrepancy between Hong Kong and mainland trade figures last month illustrates, as long as the arbitrage opportunity is there, someone will always find a way to exploit it.