The State Administration of Foreign Exchange (SAFE) inspected forex purchases by 35 banks from individuals and enterprises and forex sales to banks by 41 businesses from January to September this year. The administration announced on Tuesday that those inspections turned up a total of US$120 million in illegal transactions.

Under China's tight forex management regime, local companies are required to sell most of their legitimate forex earnings to designated banks. Most of the funds are subsequently sold to the central bank and become part of the nation's forex reserves. China's forex reserves jumped 27 percent from the end of last year to US$514.5 billion at the end of September.

"The illegal foreign exchange settlements between banks, businesses and individuals have affected the international balance of payments, resulted in abnormal growth of foreign exchange reserves and disrupted macroeconomic management," SAFE said in a statement.

Illegal forex sales to banks by both businesses and individuals were found under the capital account, under which the local currency is only partly convertible, as well as under the current account, which mostly covers foreign trade.

Foreign currency inflows have been growing rapidly in the past couple of years as businesses and individuals, as well as currency speculators, try to accumulate Renminbi-denominated assets in expectation of an appreciation of the Renminbi exchange rate and in pursuit of higher interest rates in the local market.

Signs of currency speculation became more evident this year, with capital inflow growing fast even in months when the nation's trade surplus, a typical driver of forex surpluses, shrank into negative territory.

China's new external borrowings, excluding trade credits, surged 97.8 percent year-on-year to US$83.4 billion during the first six months, SAFE reported earlier. The net inflow of foreign liabilities (new borrowings minus repayments and interest) registered US$22.7 billion for the period, six times the amount recorded a year earlier.

The rapid forex increases have resulted in greater money supply in the local banking system, as the central bank -- the People's Bank of China -- has to purchase excess dollars to enforce a narrow range for the Renminbi's exchange rate.

But that's not what monetary policymakers want to see now. Rapid monetary growth since last year has already been identified as a major driver for the frenzied fixed assets investment that has prompted worries that the Chinese economy is overheated.

SAFE also reported on Tuesday that in the first nine months it had broken up 86 underground forex dens and confiscated 50 million yuan (US$6 million) in cash.

(China Daily November 3, 2004)