Oliver's Twist | China's bulging forex reserve raises alarm of speculative fund influx

Concerns over China’s shadow banking system were back in focus this week, as one local economist raised the alarm over what he described as "disturbing" fund flow data.

The issue involves a sharp rise in China’s foreign exchange reserves in recent quarters. 

Quarterly data released last week that round out the second half of 2013 show China’s foreign exchange reserves rose by a massive US$323 billion for the six-month period. That compares to relatively modest growth of US$185 billion in the first half of 2013, and US$130 billion for 2012. China’s foreign exchange reserves ended the year at a record US$3.82 trillion.

Daiwa Capital Markets’ Kevin Lai delved into the latest data and concluded that the surge in foreign exchange reserves might be an indication of tight credit conditions and the growing desperation of mainland Chinese companies to source external funding.

Lai estimates that about US$256 billion of the foreign exchange reserves growth is “unexplained” or cannot be accounted for in terms of China’s trade surplus, foreign direct investment (FDI) inflows, or other line items.

Instead, it’s likely that rising yields in China are drawing speculative capital from across the border in Hong Kong, where interest yields are low and liquidity abundant. It’s also likely, he says, that some of the inflows represent funds tapped in Hong Kong by mainland companies in the form of loans or bond issuance “It is a huge pot of money inflows that cannot be explained by normal trade inflows…so they must be short-term speculative money flows,” Lai said.

Lai said he adjusted trade data of various Chinese government agencies compiled by the CEIC. China’s foreign exchange reserve statistics are released separately by the PBOC, which doesn’t provide a breakdown of trade flows.