Thu, Dec 25, 2014 - Page 15 News List

UBS raises flag on $1tn overseas debt

CURRENCY FLIP:It was said that Chinese companies are taking out dollar loans in Hong Kong and then using them as collateral to take out further loans in China


UBS Group AG is flagging risks from China’s US$1 trillion worth of unhedged foreign debt as forecasters see bets against the US dollar unwinding next year.

The world’s second-largest economy is more exposed to shifts in currency and interest rates than ever before because of expanding international trade and easing foreign-exchange regulations, UBS Asia banks research head Stephen Andrews said. Daiwa Capital Markets has a US$1 trillion estimate for carry-trade inflows since 2008 — bets on the difference between yields in China and overseas. It sees a 5.7 percent drop in the yuan next year.

The yuan is heading for a 2.8 percent loss this year as the US dollar gains on US Federal Reserve plans to raise interest rates and the People’s Bank of China (PBOC) cuts borrowing costs to support a flagging economy. Capital controls and record foreign exchange reserves are set to help the PBOC cope with any similar situation to 1997’s Asian financial crisis, when firms struggled to repay debt as currencies slumped, Andrews said.

“This could get very uncomfortable very quickly,” he said in a Dec. 12 interview. “I boil it down to its basics. You’ve borrowed unhedged and leveraged: you’re at risk.”

Andrews says the mechanics of what is happening are this: mainland companies deposit 20 percent to get a letter of credit from an onshore lender. They take that document to get a low-interest US dollar loan from a Hong Kong bank, which treats it like a no-risk check fully backed by the guarantor.

The companies flip those dollars back to China, where they use them as collateral to get even more letters of credit, leveraging even further, Andrews said. That money is then used to invest in China’s high-yield and often risky trust products or in the booming stock market. The profits are then used to pay off dollar borrowings.

Hong Kong banks mainland-related lending stood at HK$3.06 trillion (US$394 billion) at the end of September, 14.7 percent of total assets, according to the city’s monetary authority. Andrews said his estimate is higher as he includes trade bills and other forms of lending not included in the data, such as between sister companies in intergroup corporate transfers or letters of credit between onshore and offshore bank branches.

“There were too many cheap dollars in the market for everyone to borrow,” Daiwa economist Kevin Lai (賴志文) said on Tuesday last week. “If you just put the money in China, the carry plus appreciation is about 5 percent, so why not, right?”

Lai estimates US$1 trillion of carry-trade inflows since the first round of US quantitative easing in 2008, of which US$380 billion entered China disguised as commerce flows.

Gavekal Dragonomics (龍洲經訊) Beijing-based China economist Chen Long (陳龍) said China’s overseas debt has been growing in line with the economy and banks are healthy enough to absorb any changes in interest rates or currencies.

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