CLUSTERS of sharp-eyed men - some smartly dressed in Italian-label suits - are milling around the Hua Lian Commercial Building on Nanjing Road in Shanghai. They look around constantly, as if on the hunt for prey, occasionally entering into conversation with passers-by. If you stand curiously wondering why they are loitering around this corner of the city's major ''high street'', one of them is bound to come towards you. ''Want foreign exchange?'' the man will ask in a low voice. This is just one of the numerous illegal foreign exchange markets in Shanghai - China's financial centre - and throughout the mainland. These underground marketplaces are so common in China that people seem to take them for granted, and do not question their implications for the development of the country. The problems they can cause include the loss of foreign currency trading from the banking system, and the subsequent difficulty in monitoring the state's financial and economic policies. ''The impact on the country can be immense. The black market can upset the country's economic order,'' said Hong Kong Baptist College senior lecturer in economics Woo Tin-oy. The illegal trade in foreign currency also reflects facts of life which are probably endemic in any developing economy. China's illegal forex markets - popular with foreign, joint-venture, and probably even state enterprises, expatriate employees in the country, and local individuals - flourished with the opening of the mainland economy, which has a currency that is not fully convertible. ''Whenever a currency is not fully convertible, a black market is inevitable,'' said Tsang Shu-ki, also a senior lecturer in economics at Hong Kong Baptist College. The black market has emerged as foreign currency supply is limited and tightly controlled, and the official value of the yuan is far different from the market value. In Shanghai, black markets are ubiquitous, wooing business in places such as the much frequented Bund, and the upmarket districts around five-star hotels along Nanjing Road. But the one near Hua Ling Commercial Building is believed to be the largest. ''The black market dealers there can offer almost any kind of currency. They even have currencies from Arabs who sold their currencies for yuan to buy silk in China,'' said one source. ''Some dealers can even make transactions of up to US$1 million. That's why they can deal with enterprises. Enterprises also know they can go to them for better rates, and deals between foreign currencies that don't even involve the yuan,'' he added. The mushrooming of this underground economy points to other endemic features of a developing country: low wages, theft and smuggling. Many of the black markets are controlled by gangs. Each gang is led by a boss who is very territorial. The gangs are comprised of people from all over China, but especially Fujian, Guangdong, and Shantou, and major clients are smugglers who need to buy or sell foreign currencies. A black market dealer earns about 100 to 200 yuan (about HK$134 to $268 at the official rate) per day. This compares with the average mainlander's monthly income of about 300 yuan. And it explains how black market dealers can afford luxury goods such as designer label clothes. ''They conduct business from 10 am to 6 pm, then go out and enjoy themselves with the money they have made,'' said one source. He said the black marketeers had the support of a number of policemen. ''Some policemen use them to track thefts. They have to report a certain quota of thefts in a given period in order to continue their operations without police intervention,'' he said. ''Some of the dealers are knowledgeable of the criminal community. If, for instance, a person offers to sell them a huge amount of foreign currency and asks for an exceptionally low rate of exchange, then the dealers will get suspicious and report the person to the police,'' he said. Many enterprises on the mainland resort to the black market for better exchange rates than the legal and official swap centres, according to sources. Enterprises also use the black market to get around restrictions imposed by swap centres. Another problem is that not all enterprises have access to the swap centres, where transactions usually need to be approved on a case-by-case basis. Restrictions are also imposed on how currencies bought can be used, and a handling charge is levied for each transaction. ''Some enterprises deal in the black market because they don't want to be checked and controlled,'' said Mr Tsang. The black market is also popular with employees of foreign enterprises - including those from Hong Kong - who receive salaries in foreign currencies. ''We use the black market to exchange our money. Nobody is silly enough to change at banks, which offer official rates,'' said one foreign employee working in Shanghai. Mainlanders use the black market because of a shortage of proper foreign exchange channels. Since 1991, Chinese have been allowed to buy foreign currency with yuan at specified banks at the swap market rate. But some people have been put off by the procedures involved. They have to produce proof of reasons for needing foreign currencies - such as overseas study or travel - when they try to buy foreign currencies at the banks. Banks may also ask a client to apply for approval from the State Administration of Exchange Control, if it thinks the client is asking for more than he needs. ''There are restrictions on the amount of foreign currencies bought. They may let you have as much as US$600,000 to $700,000. But if you need to go studying abroad, for example, you may want more,'' said a Shanghai citizen. ''Also, the exchange rates are not as good as the black market rates. Foreign currencies are expensive there,'' he added. After the opening of the economy, mainland individuals have more sources of foreign currency income. Retailers now get more foreign money because tourism has increased. Some also exchange foreign currency in the black market for better rates. But this underground economy has an adverse effect on the country's economy. The black market - with untraceable transactions carried out by untraceable middlemen - makes it hard to control the foreign exchange system. ''The state may have an estimate of how much foreign currency the country will get and can plan trade, especially imports, accordingly. But the loss of the currencies to the black market instead of the banking system can mess up its import plans,'' said Mr Woo. ''Foreign currencies lost to black market dealers might have been more efficiently used if they had been channelled back into the banking system. The state could have used them on priority projects, such as the import of raw materials,'' he added. ''But money going through the black markets may be used by people to import goods which the state doesn't desperately need, such as cars,'' he said. There is also the problem caused by the disparity between the official and unofficial rates. But Beijing has valid reasons to maintain an official rate and limit the convertibility and flow of the yuan. ''At present, people don't have much confidence in the yuan. If the foreign exchange system is liberalised, everybody will rush to exchange yuan into foreign currencies,'' said Mr Woo. People in China reportedly have total savings of more than 1.3 trillion yuan. But the country has official foreign exchange reserves of only US$20 billion. If foreign exchange was liberated, the demand for US dollars would far exceed supply, causing the yuan to depreciate. So the black markets will continue to exist until the official rate and swap centre rate - which will be unified next year - level off at the real market value, and the yuan is free flowing and fully convertible. But first the yuan needs to strengthen through increased production and lowered inflation. ''If sales of China-made goods improve, then the currency would have the support it needs,'' said Mr Woo. ''Also, if the mainland's inflation rate runs at a slower rate than that of the United States, the relative value of the yuan will appreciate,'' he said. Mr Tsang said Beijing was already making steps to rectify the black market-dominated system. ''Now the Government is fixing the swap rate closer to the black market rate to attract more people to swap centres and banks for foreign exchange instead the black market,'' said Mr Tsang. On December 1, the Shanghai branch of the Bank of China launched a foreign exchange service for people to swap five currencies: the Hong Kong dollar, US dollar, sterling, deutschemark and Japanese yen. The service does not include transactions involving the yuan. However, it is the first proper channel in Shanghai, and probably China, for individuals to directly deal in foreign currencies legally without having to seek special approval.