Letters of credit (L/Cs) used to take advantage of differences in interest and exchange rates between mainland China and Hong Kong are likely to remain popular during 2016 according to analysts.

Some analysts are even predicting an increase in yuan denominated L/Cs, despite China's economic slowdown.

More trade settlements

In some respects, the yuan's popularity as an international currency has slowed. For example, yuan deposits have shrunk and interest in yuan bonds in Hong Kong is waning.

But the proportion of cross-border trade settlements in the Chinese currency reportedly increased in 2015 from 22 per cent in 2014 to 26 per cent last year.

L/C arbitrage

Companies can take advantage of interest rate differences between the two Chinese territories.

Hong Kong banks offer more than 4 per cent for yuan deposits, which can be used as collateral for L/Cs. These can then be sent to related companies on the mainland and used to obtain loans at 3 per cent from banks there.

Capital flight

Yuan trade settlement volumes may also rise as Chinese investors use misinvoicing techniques to siphon money out of the mainland.

Some analysts predict that the use of legal and illicit transactions could push yuan settlements to as much as 30 per cent of all Chinese cross-border trade settlements in 2016.

This article represents the views of the author and not necessarily those of the ICC or any of the other partners in DC-PRO.