Hot money largely from Hong Kong has been flooding into China recently through false trading and illegal capital inflows and outflows, and shoddy import-export data isn't helping matters.

On April 10, at a press conference held by the State Council Information Office, Zheng Yuesheng, Spokesman and Director of the Department of Statistics of the General Administration of Customs, said that the discrepancy on import and export data between Hong Kong and the mainland arose from different statistical methods adopted by the two sides. To find out what is behind the surging trade between Hong Kong and the mainland, Zheng said, an in-depth investigation would be made in concert with relevant departments.

On May 5, the State Administration of Foreign Exchange (SAFE) unveiled the Circular on Strengthening the Control of Foreign Exchange Inflow and Settlement, aiming to block the massive inflow of hot money by eradicating false exporting. The circular, which tacitly recognized the spread of such carry trades, managed to reverse the constant appreciation of the yuan. By May 6, the yuan-to-U.S.-dollar evaluation system closed at 6.1666, up 109 points from the previous session.

The circular made two main points. On the one hand, a limit should be imposed on foreign exchange settlement and sale. Taking the loan-to-deposit ratio of Chinese banks into consideration, it is difficult for banks to break the lower limit of synthetic position--$106 billion.

On the other hand, false exporting should be effectively curbed. The SAFE should issue risk reminder letters to enterprises that have inconsistent capital and commodity flows or excessive capital inflows, and require them to give an explanation within 10 days. If an enterprise fails to justify its actions, it should fall under strict supervision.

Moreover, the GAC has begun to tackle arbitrage activities like a "one-day tour" in bonded areas, which means both the yuan and export trade will gradually return to normal levels.

Illegal private banks are another main passage for hot money. According to analysis by professor Li Youhuan, who has traced currency inflows and outflows for years, many transactions from illegal private banks took the form of mutual hedging this year. That is to say, people who need dollars trade with those who need yuan.

In March, funds outstanding for foreign exchange hit 288 billion yuan ($47 billion) with that of the first quarter totaling 943 billion yuan ($154 billion). Li argued that a mix of elements, such as hot money, were accountable for the abnormal surge in funds outstanding for foreign exchange, rather than import and export recovery.

Local governments should not swell import and export data by encouraging falsification, which would trap the Chinese economy in an impasse.

According to media reports, at a symposium on foreign trade for seven provinces and cities in east China held on April 1, 2012 in Ningbo, local governments pledged to secure 10-percent growth in foreign trade. The goal presented by the provinces was subcontracted to cities, which spurred some cities to turn a blind eye to false trading and other arbitrage activities. As a result, the yuan began to depreciate at home and appreciate abroad, cornering honest manufacturing companies. Only by enhancing international competitiveness can traditional exporting cities like Wenzhou, Yiwu and Dongguan get out of the current dilemma.

The negligence of regulators and customs authorities over the soaring trade in bonded areas is unforgivable. Not until the abnormal data attract attention did they begin to respond with a vague explanation. Falsification and speculation will not yield desired economic results.

The circular is the first step, and much remains to be done by supervisory departments and local governments.

This is an edited excerpt of an article by Ye Tan, a financial commentator, published in National Business Daily