Foreign exchange regulator warned Monday that it descovered covert financing activities under the guise of foreign trade prepayments.

The State Administration of Foreign Exchange (SAFE) discovered such behavior in its nationwide spot check conducted in the second half of 2003 of designated banks with foreign exchange payment businesses, a statement posted on the SAFE's Web site over the weekend said.

Exporters sometimes receive advance payments from their foreign trade partners to fund their production. However, some prepayments have been granted without actual trade transactions taking place and therefore may have involved illegal capital flows, the SAFE statement said.

Some exporters have used the prepayments to finance transactions other than trade-related activities, and treated them as a means of obtaining more foreign currency inflows, SAFE said, without specifying the names of parties involved.

SAFE said it will closely track large-value prepayments which happen too frequently and which don't match the exporters' operating scales.

It also plans to further improve its foreign exchange management policies to control and curb such activity.

China maintains strict controls on its capital account to prevent a sudden flight of speculative funds from hitting its still-fragile local economy.

Its currency, known as the yuan or renminbi, is only convertible on the current account and even then is kept in a tightly managed band of around 8.277 to the dollar.

However, the gradual removal of barriers to foreign trade and investment has increased China's exposure to the outside world and posed challenges to the regulator on the supervision of the country's foreign exchange market.

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