THE FLIGHT OF THE RENMINBI

Some bad news and some good news about China’s shady trade data

January 15, 2013
January 15, 2013

This article has been corrected.

Last week, China boasted fantastic December export data: a 14.1% increase year-on-year. But not everyone is buying it. “It is possible that local governments may have tried to boost exports data by either making round trips in special trade zones … in an attempt to improve the annual exports data,” wrote Goldman Sachs’ Beijing-based economists Yu Song and Yin Zhang, as Bloomberg relays. Meanwhile, UBS economists noticed a conspicuous difference between China’s reported exports to South Korea and Taiwan and what those countries documented.

What gives? Trade data discrepancies often signal shenanigans afoot among Chinese exporters. In this case, that 14.1% was likely due to companies clearing customs at bonded warehouses, using the same shipment several times over, in order to rack up export receipts for value-added tax refunds before the end of the year.

Sometimes, though, it goes the other way—exporters declaring less than they actually ship out, in order to keep a portion of their earnings outside the Chinese authorities’ monitoring system. This trend has given rise to concerns about capital flight—the idea that Chinese business people are hoarding cash overseas to reduce their financial exposure to China. There are signs that even the Chinese government is worried; Reuters reports that officials from the People’s Bank of China, the country’s central bank, recently wrote that, “in the context of narrowing surpluses on the current account and capital and financial accounts, we must shift from guarding against the risk of capital inflow to guarding against capital outflow.”

If the problem is big enough for the government to acknowledge, surely the preponderance of fake invoicing means that China is edging into the danger zone, right? Nah, argue Martin Kessler and Nicholas Borst of the Peterson Institute for International Economics. There is a crucial distinction between round-tripping designed to game taxes and the sort of capital flight that reflects a “sell” rating on the Chinese economy, they say:

Capital round tripping is a major phenomenon in China. Funds leave China, enter Hong Kong or an offshore financial center, and then return to China as foreign direct investment. The motivation for this round tripping is to take advantage of tax benefits, greater legal protections, looser capital controls, and other special incentives offered to foreign investors.

The fact that, in 2011, Hong Kong, the Cayman Islands and the Virgin Islands made up 71% of Chinese FDI suggests to Kessler and Borst that the majority of China-bound FDI is making a brief rest stop in a tropical tax shelter before returning. In addition, due to more recent liberalization of restrictions on export-import settlement in Hong Kong, there’s now a glimmering opportunity for exchange-rate arbitrage, which former People’s Bank of China monetary committee member Yu Yongding explained in a paper last year.

If this analysis is correct, there’s nonetheless a major downside for China: it’s losing out on a big chunk of potential tax revenue. And that’s okay, as Kessler and Borst see it. The government’s priority should be policies to attract foreign investment to help China’s manufacturers create higher-value products, as opposed to cracking down on tax collection. The government has begun loosening controls on how foreign capital can enter China, and with FDI slowing in recent months, this is probably a good idea.

So while it’s probably best to rein in the enthusiasm about China’s export rebound, the good news is there’s also no need to freak out about capital flight just yet.

Correction (Jan. 16, 3:30 p.m. ET): An earlier version of this article misattributed the quote from Martin Kessler and Nicholas Borst’s blog post. This article has been corrected to cite the quote accurately.

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