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How To Play The Great China Rate Game

Difficult credit circumstances in China add to the emerging market chaos, yet serve as a huge money magnet. But who’s capitalizing on the dilemma? Breakingviews’ John Fooley explains who stands to benefit from all of this confusion in the central bank…

Everyone Wants a Piece of China

John Fooley: “Right now China looks to most financial investors like a giant speculative bull’s-eye. Rates within China are higher than in most places in the world. You can go into any bank and buy a wealth management product that will give you 6% return for a year whereas elsewhere, you can borrow U.S. dollars in Hong Kong for about 1%. So everyone who can currently has an incentive to pile money into the country and the central bankers are worried about this. They said on Friday that they’re facing pressure from capital inflows.”

Blame the Exporters

John Fooley: “Now normally you would blame sinister Wall Street speculators for this kind of arbitrage, but in this case it’s probably not them. It’s quite hard for global investors to bring money into China because of its strong capital controls. The people who are doing this more actively are companies – exporters. People who already do business across China’s borders and have huge trade flows that they can use to legitimately or illicitly bring money from Hong Kong into China. That’s happening all over the place and it’s creating all kinds of wonky data. When we see trade figures coming out that say that volumes are going one way and prices are going another way, it’s often a sign that money is being brought into the country to benefit from this rate arbitrage.”

Rates vs. Shadow Banking Sector

John Fooley: “Now it’s not easy to see what China’s planners can do about this. They’ve deliberately let rates rise to try and squeeze the shadow banking sector which many people think is bringing all kinds of risk to the economy. Now that’s kind of working, but if they want to stop these capital inflows from pouring in, the only way really is to let rates fall again and let the shadow banking sector thrive. So as long as the central planners are more concerned about China’s shadow banking risk than they are about all this hot money flowing over the border, this lucrative yuan arbitrage is likely to go on for quite some time.”

Either way, something has to give, and China will need to make some important decisions to keep a prosperous economy.