RMB Notes

Hardly a week passes without at least one article on Chinese currency policy by at least one major newspaper. In the ongoing debate over maintaining, adjusting, or abandoning the RMB’s peg to the dollar, one commonly cited reason in favor or adjustment is the increasingly large flow of speculative capital into China.

Consider this report, posted yesterday and updated today by the Financial Times:

The World Bank on Wednesday said China should revalue the renminbi and abandon the dollar peg in favour of a link to a basket of currencies.

It warned that without revaluation, speculative capital flows could destabilise economies in the region.

Homi Kharas, the bank’s chief economist for the region, said there was no imminent risk of a financial crisis caused by currency speculators, like that in the late 1990s, but “very large volumes of money” flowing into the region threatened economic distortions.

And just how large are the “very large volumes of money” currently flowing into China? Because such flows are illegal, gathering accurate data is impossible. But it is possible to make reasonable estimations. According to China’s central bank and Reuters:

China’s foreign exchange reserves jumped $49.2 billion in the first quarter to a record $659.1 billion, the central bank said on Thursday, signalling persistent inflows of capital betting on a yuan revaluation.

China posted a trade surplus of $16.6 billion in the first quarter, compared with a trade deficit of $8.4 billion a year earlier. Foreign direct investment in China was $13.4 billion in the first quarter, up 4.5 percent on the year.

That left some $19 billion* in other transactions on the balance of payments, much of which analysts believe was speculative money inflows betting on a revaluation of the yuan.

One popular desitination for these speculative inflows is the property market. By converting U.S. dollars into RMB, and then investing in China’s booming real estate sector, a speculator doubles his chances of profit – once from the rise in property prices, and once again from the rise in the price of the RMB in dollar terms should the Chinese government revalue.

And just how booming is real estate in China, you ask? According to Brian Bremner and Frederik Balfour’s excellent article Businessweek Online:

New hundred-square-meter apartments in posh sections of Shanghai have doubled in value, to $550,000, since 2003. High-end properties in the Chinese megalopolis have shot up 20% during the past three months alone. It’s not just Shanghai. UBS Securities (UBS ) says overall urban land and property prices in China last year were up 70% over 2001.

Sounds pretty tempting, no?

Although figures on speculative capital flows and the latest global real estate boondoggle are a common sight in print and online, one thing I have yet to see addressed is exactly how speculators are moving into RMB positions given the supposedly tight controls on foreign exchange in China.

Exchanging small amounts of dollars for RMB and vice-versa is easy. Anyone who has travelled to China knows that this can be done at the airport (provided one holds on to those receipts!) or even through black market money changers.

But one can’t expect to purchace a prime piece of Shanghai property with the one thousand dollars worth of RMB purchased at the airport exchange desk. And even if one could purchase the property, and even if one were able to sell it for a profit, and even if the Chinese government did revalue the RMB, without a recepit for that new amount all that profit would be for naught, stuck inside China.

But if it were that easy for the Chinese government to stop speculative capital flows, there would not have been $19 billion worth of them in the first quarter of this year.

So how do they do it?

I was pleasantly surprised to see that the Mure Dickie and Richard McGregor of the Financial Times answered the question today in this article. Unfortunatly, it’s only accessable to FT.com subscribers, or in the print edition, but consider this fascinating introductory anecdote:

Using his permanent residency in France, Mr Hu set up an offshore company to buy property from a real estate business he established in China… The property did not actually exist. But the paper trail allowed Mr Hu to apply to [legally] bring 284,000 euros into China.

The Wenshou entreprenuer – who was unmasked last month by regulators – offers an example of the efforts that individuals and companies have been making to move funds into the renminbi amid widespread speculation that Beijing is moving towards a significant revaluation.

I still have no idea how Mr. Hu planned on getting his profits back out of China, but the story is interesting nevertheless. For anyone interested, the FT article goes on to list five other commonly used methds to, “bet on the renminbi despite China’s capital controls.” Here are three for your consideration (comments mine):

1) False trade accounting – Intentionally mark up the prices of your exports to bring in more dollars.

2) Money smuggling – Black market banks and corrupt officials serve your forex needs.

4) Increasing overseas leverage – Unless you’re one of the lucky few companies allowed to borrow abroad, forget about it.

Still not sure how they plan on changing back to dollars, but I suppose if the money is there, ways can be found.

*Forex numbers are online here, but for the life of me I can’t find balance of payments data, so don’t ask how Reuters came up with the $19 figure. If anyone cares to work out the math, it would be much appreciated.

7 thoughts on “RMB Notes”

  1. Just because profits can’t be repatriated now doesn’t mean that funds transfers won’t loosen up in the future. Post-Soviet Russia, much like China today, allowed foreign investors to send money INTO the country, but were not allowed to bring any of their profits back home. This led to all income being reinvested, and actually let McDonalds Russia to become one of the largest real estate holders in the entire country. I’ve posted an article on this below from the NYT- I would have just linked but the formatting on the International Herald Tribune website was screwed up and illegible.

    In Russia, McDonald’s uses burger-dollars for real estate

    By Erin E. Arvedlund The New York Times

    Friday, March 18, 2005

    The busiest McDonald’s restaurant in the world is not in the United States but thousands of kilometers away in Pushkin Square.

    The store serves 30,000 customers a day, as busy as on its opening day on Jan. 31, 1990. The menu is mostly the same as in the United States, with the addition of cabbage pies and a few other traditional Russian food items.

    The Pushkin Square restaurant is important as well because it is the jewel in a growing real estate empire that ranks McDonald’s among the largest corporate landowners in Russia.

    Other big companies have begun to follow its lead and are getting a foot in the door by becoming real estate developers. Still, the practice is not without its pitfalls: Three of McDonald’s office buildings in central Moscow have been up for sale for well over a year.

    McDonald’s real estate venture began in the early 1990s, when it had no way to convert the rubles that customers paid for its hamburgers and milkshakes into another currency. So it spent the rubles to buy farmland and build office towers, a distribution center and a factory in the Moscow suburbs – which became known as McComplex – and in 1993 the company built its first office building, just two blocks from the Kremlin. Tenants including Coca-Cola and Upjohn moved in.

    More property was added as McDonald’s opened new restaurants, buying many restaurant properties because business loans are not easily available in Russia to run small businesses, including the franchises that McDonald’s sells in other countries. The chain now employs 17,000 Russians in 37 cities and plans to open 25 more restaurants this year, mostly in Moscow and St. Petersburg, and 75 by 2007.

    Buying land in central Moscow now is nearly impossible, but McDonald’s prevailed by getting in early and working closely with the city.

    “We had a great relationship with the city of Moscow,” and the mayor at the time agreed to sell McDonald’s the central property, said George Cohon, head of McDonald’s Canada, who persuaded Soviet officials to open the restaurant in Pushkin Square.

    Real estate analysts and industry experts here conservatively value the 127 McDonald’s restaurants in Russia, plus its land, storage warehouses and distribution centers, at $115 million, although that figure could be much higher if the company succeeds in selling the office towers and leasing back the space for its own use. Its revenue in Russia last year totaled $310 million.

    In central Paris and London, “we do long-term leases, but we were able to buy more here,” Russ Smyth, the McDonald’s president for Europe, said in an interview on the Pushkin Square store’s 15th anniversary. He declined to put a value on the Russian real estate portfolio but added, “It’s definitely a hidden asset.”

    The company’s early lock on top locations is helping it stand up against other corporations seeking a toehold in Russia, including the coffee giant Starbucks, which has yet to enter the country. In some stores, like the one at the Old Arbat pedestrian tourist mall, it has added cafés with soft lights and a dessert menu. Perhaps as a pre-emptive strike, McDonald’s is also starting to serve stronger coffee.

    Other multinationals have mimicked its developer tactics. The furniture retailer Ikea in 2002 opened a 195,000-square-meter, or 2.1 million-square-foot, mall between Moscow’s main airport, Sheremetyevo, and the city center, and a second big mall began operations recently. Last year, Ikea opened its first store in Kazan, in the Tatar region, and plans stores in 10 other cities with populations of more than a million.

    The French supermarket chain Auchan operates stores in Russia, and Wal-Mart Stores is expected to open stores as well; it is said to have looked at locations in St. Petersburg.

    Russia is now one of the fastest-growing McDonald’s markets, along with Western Europe and China. “They’re contending with desperate times in America since there’s no room to build new restaurants,” said Richard Adams of Franchise Equity Group, an advocate for McDonald’s franchise owners.

    Real estate agents say the three office buildings in central Moscow that McDonald’s is having trouble selling have appreciated 40 percent in the past decade and could fetch $45 million. That is in part because high-quality office space in Moscow is in short supply. In 2004, office rents rose an average 30 percent, according to the real estate firm Noble Gibbons.

    But the three properties were “built very early, and the quality may not have been so good,” said Ekaterina Konstantinova, an analyst with the Troika Dialog commercial real estate fund.

    McDonald’s has been able to avoid some problems here that have troubled it in the West. The controversy surrounding “Super Size Me,” a film about a man’s monthlong experiment eating at McDonald’s three times a day, and accusations that fast-food chains like McDonald’s promote obesity, are not issues for Russians, some of whom demand mayonnaise with 40 percent fat content. Nor does the use by McDonald’s of low-paid migrant workers seem to bother many – Russian wages average $250 a month.

    Some even argue that McDonald’s is identified in the public mind with glasnost and perestroika, the policies of openness and restructuring under Mikhail Gorbachev in the final years of the Soviet Union.

    “There was no food in the stores,” recalled Vladimir Malyshkov, the deputy mayor of Moscow who helped broker the original deal for the Pushkin Square restaurant. “I was under investigation for allocating meat to McDonald’s.”

    Now, looking back, he said, “It was the first precursor of a free life.”

  2. Interesting article. Thanks for posting it. All I would say is that the last thing China needs right now is more investment – that is one of their major problems. More on this in the next post, hopefully sometime later today.

  3. Looking forward to it. One more thing, if you post a comment without the correct registered email address then your gravatar icon won’t show up next to your name. This goes for anyone using gravatars. Hmm, which reminds me I should add a signup link and so on…

  4. Great article, 900 sq. meter for US550,000 in SH? not possible, you meant 900 sq. ft new apartment unit I suppose.

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