Reuters News - Insight: The big money bails on Argentina - again

Argentina's President Cristina Fernandez de Kirchner waves as she arrives for the inauguration of a university in Buenos Aires May 16, 2013.

Credit: Reuters/Marcos Brindicci

By Brian Winter

BUENOS AIRES | Thu Jun 13, 2013 1:07am EDT

(Reuters) - More than a decade after Argentina's epic financial collapse of 2001-02, many investors are rushing for the door once again.

From big Chinese and Brazilian companies like miner Vale do Rio Doce SA, to small-business owners and savers, the fear of a new crisis has led to canceled investments and suitcases of cash leaving the country.

The mass exodus, which has been limited only by leftist President Cristina Fernandez's capital controls, is threatening to undermine Latin America's No. 3 economy even further by leaving it short of hard currency and new jobs.

The underlying problems range from Fernandez's hostile treatment of the private sector, to severe financial distortions such as a parallel exchange rate, to the general feeling that Argentina is due for one of the periodic spasms that have racked the country every 10 years or so going back to the 1930s.

Some say such worries are overblown, arguing that Argentina has defied doomsday predictions for the past decade, which was by some measures its best economic run since World War Two.

Yet for many, the feeling is of a gathering storm.

"The end of this story has already been written, and it ends in crisis," said Roberto Lavagna, who as economy minister from 2002 to 2005 helped create Argentina's current export-driven policy framework, and is still widely respected on Wall Street.

While everyone agrees any crisis won't be as bad as the 2001-02 meltdown - which saw nationwide riots, two presidents quit, and the economy shrink by one-fifth - it could still be enough to severely disrupt lives and business plans.

By relying on short-term fixes such as price controls and bans on Argentines buying dollars, Fernandez may just be delaying the inevitable while piling up even more problems.

"The longer they try to delay things, the worse they will be," said Lavagna, who worked for Fernandez's late husband and predecessor, Nestor Kirchner, before falling out over what he saw as the couple's increasingly anti-business agenda.

"You can't have growth without investment."

Key ministers in Fernandez's government declined to be interviewed for this story.

Following a sharp slowdown in Argentina's economy over the past year, and growing concern in places like Washington and Brasilia, Reuters recently spoke to about two dozen leading figures in industry, finance, academia and politics to try to gauge where the country is headed.

Some declined to speak on the record, citing growing efforts by Fernandez's government to intimidate its critics. Others - including Lavagna, who has become a leading opposition figure - were clearly informed by a political point of view or agenda.

Yet even among those without an ax to grind, the sense is that Argentina has lapsed into its old habit of scaring away private capital, one of the main reasons why it has steadily declined from its perch as one of the world's richest nations in the 1930s.

"It sure sounds like trouble to me," said David Rock, a professor at the University of California at Santa Barbara and author of several books on Argentina's economic history.

"What they're doing right now, it can't be sustained," Rock said. "It's hard to believe it's happening again."

A ROGUE

In truth, Argentina has been something of a financial rogue for years. Since defaulting on $100 billion in debt during the last crisis, the country has been cut off from capital markets and considered a highly risky place to do business.

Fernandez confiscated private pension funds to help pay government debts in 2008, and has nationalized some companies. Her government is widely accused of doctoring economic data, inflation runs at about 25 percent, and foreign firms are forbidden from sending profits abroad.

Until recently, though, the economy continued to grow, often at an annual pace of 8 percent or higher.

So what has changed?

First, the effect from years of high inflation has taken its toll, making Argentine industries uncompetitive at a time when prices for its key commodities like soy are falling.

And second, the major business partners the country hadn't yet alienated - Brazil and China - have also begun to turn away.

Vale's decision in March to cancel a $6 billion investment in a new potash mine was emblematic.

The company, which is privately held but heavily influenced by the Brazilian government, walked away because the growing gap between Argentina's official and black-market exchange rates would have forced it to shoulder costs in dollars at a level as much as 50 percent higher than it would receive profits.

Afterward, Interior Commerce Secretary Guillermo Moreno - Fernandez's point man on contentious economic issues - demanded a meeting with Brazilian officials. He then threatened to have Vale executives in Argentina detained unless the company reversed its decision, according to three Brazilian officials with knowledge of the conversation.

Neither Moreno nor his office responded to repeated requests for comment. Economy Minister Hernan Lorenzino also did not respond to interview requests.

The hostile treatment, plus other recent clashes, infuriated Brazilian President Dilma Rousseff and led her government to "downgrade" ties with Argentina, two senior officials said. Shortly thereafter, state-run oil company Petrobras stepped up efforts to sell its assets in Argentina.

Difficulties with the Chinese have been quieter, but also troubling. The Heilongjiang Beidahuang State Farms Business Trade Group, a Chinese investment entity, had agreed to help build a range of large projects from wind farms to port improvements to railroads in Buenos Aires province.

"These have been delayed because of the political situation," said Oscar Gomez, an adviser to the group.

"Today, whatever money they have budgeted, it runs out in two months," Gomez said, citing inflation and the parallel exchange rate, among other factors. "Everything's working against Argentina. There's no investment today because there's nothing in it for anybody."

CHILL IN LOCAL INVESTMENT TOO

Chinese companies have also suspended or slowed down huge investments in shale gas and urea, a fertilizer, said Diego Guelar, a former ambassador to the United States and author of a forthcoming book about Argentina and China.

"Brazil and China were our last dynamic partners, so now what?" Guelar said. "Who will create jobs?"

The answer doesn't seem to lie with Argentine companies. A business confidence index produced by the University of Belgrano fell 4.4 percent in the first quarter compared to the year before - putting it near levels last seen during the 2008-09 global financial crisis.

Economists say the private sector likely contributed zero net jobs to the economy last year, with only the government picking up the slack - but that may have run its course, too. Unemployment rose a full percentage point in the first quarter, to 7.9 percent, a three-year high.

Some Fernandez supporters argue that robust consumer spending will be enough to sustain the economy. And it's true that, unlike the last crisis, Buenos Aires' famed steakhouses and cafes continue to bustle with customers well past midnight.

"We do have a severe problem with private investment, but that's always been an issue here," said Artemio Lopez, a political analyst. "You have speculators and unproductive capital that flee the country whenever they can."

Not everybody is running away - U.S. oil major Chevron Corp said last month it would invest up to $1.5 billion in shale in Argentina's south.

There are still some 500 U.S. companies in Argentina, and many are profiting and continuing to invest, according to a source close to the business community. But the same source conceded that many invest because "they have no choice" - Fernandez's capital controls prevent them from sending earnings back home.

'IT'S TRAGIC'

Official data, often questionable in Argentina, suggests those controls have helped contain the damage - at least for now.

Capital flight slowed from $21.5 billion in 2011 to $3.4 billion in 2012, with a slight net inflow of $110 million in the first quarter this year, according to the central bank.

Yet other evidence suggests the pressure for money to escape is intensifying. In recent months, Fernandez has passed several new measures such as a limit on cash withdrawals using credit cards abroad, and a surcharge on purchases of airline tickets.

The demand for hard currency is such that Argentines pay a premium of 60 percent over the official exchange rate to buy dollars on the black market. Many believe that Fernandez is just trying to hold the economy together until legislative elections in October, causing many to take refuge now.

Argentines frequently tell stories in private of dollars they've stashed in safe-deposit boxes, under their mattresses, and in suitcases on trips to banking havens like Miami or neighboring Uruguay.

"Nobody wants to be the last one left," said Marcos Aguinis, an author of several bestselling political books and novels. "It's tragic, the predictability, but this is clearly falling apart once again."

Indeed, one of the most commonly heard phrases in Buenos Aires at the moment is "fin del ciclo" - the end of the cycle, a uniquely Argentine notion that the economy and often the government must regularly implode to make way for something new.

So why does that keep happening?

"I've been trying to answer that question for 50 years," said Rock, the historian. "To be honest, I still don't know."

BBC News - Offshore wind industry in government investment boost

The government says Britain has more installed offshore wind capacity than anywhere else in the world

The government is to set up a new body aimed at attracting increased investment into the British offshore wind industry.

Business and energy minister Michael Fallon said the Offshore Wind Investment Organisation (OWIO) will be a joint venture between industry and government.

The body will be led by "a senior industry figure", he said,

He also announced £2m of support for three wind innovation projects.

"Offshore wind is a major success story for the UK, and we want to boost levels of inward investment", he said.

"We already have more installed offshore wind than anywhere else in the world, and this brings enormous economic benefit to our shores, supporting thousands of skilled jobs."

The government is also awarding £540,000 to Kent-based Power Cable Services to help with their underwater electricity cable technology project.

Aquasium Technology, with partners Burntisland Fabrications and TWI, will receive £769,600 towards more cost-effective manufacturing techniques.

And Cambridge-based Wind Technologies will receive £728,355 to design and manufacture a new type of turbine drive mechanism.

The UK has approaching 1,000 offshore wind turbines generating nearly 3,500 Megawatts of capacity - more than any other country in the world.

Mr Fallon is due to give details of the government plans at Renewable UK's Offshore Wind 2013 conference in Manchester.

BBC News - Latvia to become 18th eurozone member from 2014

Latvia will become the 18th country to use the euro after being approved for membership by the European Commission.

Shops like these in Latvia's capital, Riga, will trade in euros from 2014

In a report, the Commission confirmed that the Baltic state had met the criteria for joining the single currency.

Latvia is keen to strengthen ties with western Europe and reduce its dependency on Russia.

Officials said the eurozone had defied those who predicted it would collapse under the sovereign debt crisis.

'Widespread enthusiasm'

The country will start using the currency at the beginning of 2014 after meeting the criteria for membership, including low inflation and long-term interest rates, as well as low public debt.

EU Economic and Monetary Affairs Commissioner Olli Rehn said Latvia's desire to adopt the euro was a sign of confidence in the single currency.

"Those who predicted a disintegration of the euro...were simply wrong," Rehn told a news conference.

The BBC Brussels correspondent, Matthew Price, said that unlike some established members of the zone, Latvia was well within the economic limits set by Brussels for joining.

"In much of Eastern Europe there's widespread enthusiasm - certainly among policy makers - for joining the single currency," he noted.

"However, polls suggest that many in the country are worried the switch could drive prices higher."

Anti-euro parties won more than half of the vote in elections in the capital, Riga, last weekend.

Financial risk

Latvia underwent one of Europe's toughest austerity programmes after the 2008-2009 financial crisis knocked a fifth off its GDP.

It received a 7.5bn euro bailout in 2008, but it has now repaid the loans.

The membership still has to be approved by EU leaders and the European Parliament, but that is seen as a formality.

EU finance ministers are expected to sign off the accession in July.

The European Central Bank (ECB) also gave its blessing to Latvia on Wednesday ahead of the Commission's announcement, but warned high foreign deposits in its banks were a risk to financial stability.

"The reliance by a significant part of the banking sector on non-resident deposits as a source of funding, while not a recent phenomenon, is again on the rise and represents an important risk to financial stability," the ECB said.

Sky News - Net Lending Falls by £300m As Banks Cut Loans

Business leaders express concerns about a lack of credit to small firms, and call for more competition among lenders.

The Bank of England projects a pick-up in lending later this year

The number of loans offered to businesses has fallen - despite lenders drawing down billions from a state-subsidised cheap credit scheme designed to revitalise Britain's sluggish economy.

The Bank of England reported a £300m fall in net lending by banks and building societies taking part in its flagship Funding for Lending Scheme in the first three months of 2013.

Part-nationalised Lloyds Banking Group lent almost £1bn less during the quarter, despite having borrowed £3bn from the project.

Taxpayer-backed Royal Bank of Scotland also shrunk its net lending by £1.6bn in the quarter, but has borrowed £750m from the Bank of England and Treasury scheme.

Spanish-owned bank Santander cut its net lending by £2.3bn as it continued its retreat from riskier parts of the mortgage market.

The FLS offers lenders discounted loans in return for boosting the flow of credit to the economy, and was recently beefed up to extend more loans to credit-starved small businesses after criticism over its impact.

Three banks - Lloyds, RBS and Santander - cut their credit to the economy

While the scheme has been deemed a success in terms of cutting the mortgage rates for first-time buyers, it has so far failed to boost net lending to businesses.

Since the introduction of the scheme £16.5bn has been issued to banks, while net lending has dropped by £1.8bn during the same period.

The BoE blamed the credit squeeze on lenders shrinking their "non-core" portfolios, such as commercial property loans.

It did not split out lending to homebuyers and businesses, but said flows to individuals had been "typically positive", while credit to businesses had "mostly been negative".

However, it added net lending to companies was "less negative" than a year ago, and that it would "take time" for the scheme to feed through to bigger lending volumes.

Paul Fisher, executive director for markets at the BoE, said the net lending fall was "broadly as expected".

He added: "The plans of the FLS participants suggest that net lending volumes will pick up gradually through the remainder of 2013."

Barclays borrowed £6bn from the FLS and increased its lending by £1.1bn during the quarter, while Nationwide Building Society also hiked its lending by £1.2bn after drawing £2.5bn from the scheme.

There were also major credit injections from firms including Tesco Bank, Virgin Money and Coventry Building Society.

John Longworth, director general of the British Chambers of Commerce (BCC) criticised the scheme for failing to boost credit to businesses.

He said: "The real test for Funding for Lending is whether it is able to get credit flowing to young and fast-growing businesses.

"Unfortunately many of these growth firms are still being left out in the cold when it comes to accessing finance, which prevents them from expanding, creating jobs and helping to drive a business-led recovery."

Bloomberg News - Ignatiev Sees Russian Easing Hindered by Economy’s Crosscurrents

Russia’s central bank faces a “very difficult choice” when it meets next week to review interest rates as conflicting economic data undermine the case for monetary stimulus, outgoing Chairman Sergey Ignatiev said.

“The decision won’t be simple because the situation in the economy isn’t that simple,” Ignatiev, who steps down as chairman later this month, said today at a banking conference in St. Petersburg. “Some economic indicators count in favor of one decision, others support another.”

Economic growth in Russia, the world’s largest energy exporter, has slowed to the weakest pace since a contraction in 2009 as a record-long recession in the euro area saps exports of oil, metals and and natural gas. While corporate investment is sagging and car sales fell in April, signaling the need for monetary stimulus, inflation above the central bank’s target range is confounding policy makers, according to Ignatiev.

“It’s possible we’ll keep all interest rate unchanged,” Ignatiev said. “I don’t rule out another decision, under which some interest rates will be reduced and others kept unchanged.”

Bank Rossii kept its main lending rates unchanged for an eighth month on May 15 and reduced by a quarter point the costs of some longer-term loans, including those backed by gold and non-marketable assets. Ignatiev said the central bank won’t consider raising borrowing costs at their next board meeting on June 10, the last one headed by him before Elvira Nabiullina, PresidentVladimir Putin’s economic aide, takes over two weeks later.

Investor Bets

Investor bets are pricing in a smaller reduction in rates. The three-month MosPrime rate, which large Moscow banks say they charge one another, may drop 9 basis points, or 0.09 percentage point, in the next three months, according to forward rate agreements tracked by Bloomberg. That compares with a cut of 49 basis points, the most since October 2009, forecast May 22.

The central bank may keep the refinancing rate unchanged at 8.25 percent at the next meeting, according to 18 of 25 economists surveyed by Bloomberg. Seven predict a quarter point cut.

Lending to companies and households increased 19 percent as of May 1 compared with a year earlier, Ignatiev said. In real terms, the advance was 11 percent, which is “much faster” than the pace of the economy. That suggests the pace of lending isn’t weighing on the economy, Ignatiev said.

Inflation Spike

Consumer price growth, which Ignatiev helped drive down to a record low 3.6 percent pace in April and May of last year, has surged to more than double that level to above this year’s target range of 5 percent to 6 percent, preventing policy makers from using easier borrowing costs to shore up the stumbling economy. Inflation accelerated for a second month in May to 7.4 percent, the highest since August 2011, the Federal Statistics Service in Moscow said yesterday. Economists projected the rate would increase to 7.3 percent.

The surge in prices is largely related to a quick rise in some consumer costs because of a bad harvest last year, Ignatiev said. While price growth will probably start slowing in the second half, Ignatiev said he sees a risk that inflation expectations may rise, further fanning prices.

The central bank has held the overnight and one-week repurchase rates, the main tools used to provide banks with cash, at 5.5 percent since September, when they were raised a quarter point. The refinancing rate, used as a signal rate by the bank, has been held at 8.25 percent over the same period. Bank Rossii reduced rates on lesser-used instruments by a quarter point at the last two meetings, which Ignatiev said in April was a “first decision” toward easing.

Ignatiev’s Tenure

Ignatiev, 65, has led the regulator since 2002, seeing the country’s banking system through the 2008-2009 financial crisis that toppled Lehman Brothers Holdings Inc. and allowing the ruble to trade more freely.

Ignatiev has said he plans to accept Nabiullina’s offer to remain at the bank as an adviser once she becomes chairman. The handover to Nabiullina, 49, a former economy minister comes as the central bank prepares for a merger with the main markets regulator and the introduction of Basel III requirements for capital adequacy later this year.

Ignatiev, who left after more than a decade of teaching in what was then Leningrad to join the government as a deputy economy and finance minister in 1991, also worked in 1992 and 1993 as a deputy head of the central bank. He was Alexei Kudrin’s first deputy at the Finance Ministryin 2002 when Putin nominated him for the first of three terms as chairman.

By Scott Rose

BBC News - US targets Iranian currency with fresh sanctions

The US has unveiled fresh sanctions against Iran, targeting its currency, as it increases the pressure on Tehran to abandon its nuclear programme.

The Iranian rial has been highly volatile amid sanctions imposed against Tehran

These include penalties on anyone facilitating "significant" transactions in the rial or holding significant amounts of the currency outside Iran.

A US official said the move would force institutions to dump rial holdings and weaken the currency further.

This is the first time the US has directly targeted the Iranian currency.

"This promises to make Iran's weak currency, even weaker and more volatile," the US official was quoted as saying.

"The idea here is to make the rial essentially unusable outside of Iran."

The Iranian currency has fallen significantly against the US dollar over the past couple of years, hurt by a slew of sanctions against Tehran's key sectors.

'Serious escalation'

This is the ninth set of sanctions that President Barack Obama's administration has imposed against Iran.

The latest ones also include sanctions targeted at Iran's automobile sector, one of the key employers and contributors to Iran's economy.

The US has banned the sale or transfer of goods or services to be used in Iran's automobile manufacturers.

"It's a serious escalation of sanctions because the administration is blacklisting the auto sector which is the second largest employer in Iran after the energy sector," said Mark Dubowitz, of the Foundation for Defense of Democracies.

Mr Dubowitz added that the move against the auto sector indicated that the US was concerned it could be used to procure "dual use" technologies such as parts for centrifuges which are involved in the uranium enrichment process.

Meanwhile, White House spokesman Jay Carney said that while the US had been increasing its pressure on Iran, it was still open to a "diplomatic solution that allows Iran to rejoin the community of nations if they meet their obligations".

"However, Iran must understand that time is not unlimited," he said.

"If the Iranian government continues down its current path, there should be no doubt that the United States and our partners will continue to impose increasing consequences."

Reuters News - Insight: North Korean economy surrenders to foreign currency invasion

. North Korean leader Kim Il-sung is seen on this 5000 North Korea won banknote in this photo illustration taken in Shanghai May 23, 2013.

Credit: Reuters/Carlos Barria

By John Ruwitch and Ju-min Park

CHANGBAI, China/SEOUL | Sun Jun 2, 2013 9:32pm EDT

(Reuters) - Chinese currency and U.S. dollars are being used more widely than ever in North Koreainstead of the country's own money, a stark illustration of the extent to which the leadership under Kim Jong-un has lost control over the economy.

The use of dollars and Chinese yuan, or renminbi, has accelerated since a disastrous revaluation of the North Korean won in 2009 wiped out the savings of millions of people, said experts on the country, defectors and Chinese border traders.

On the black market the won has shed more than 99 percent of its value against the dollar since the revaluation, according to exchange rates tracked by Daily NK, a Seoul-based news and information website aboutNorth Korea.

North Korea is one of the most closed countries in the world, so it is difficult to determine what impact this could ultimately have on Kim's regime.

But experts said the growing use of foreign currency is making it increasingly difficult for Pyongyang to implement economic policy, resulting in the creation of a private economy outside the reach of the state that only draconian measures could rein in.

For now Pyongyang appeared to be capitulating, rather than trying to stamp out foreign currency use, they said.

Estimates of how much hard currency is in circulation vary, but an analyst at the Samsung Economic Research Institute in Seoul put it at $2 billion in an April study, out of an economy worth $21.5 billion, according to some assessments. Pyongyang doesn't publish economic data.

The use of dollars and yuan is now so pervasive there is little Pyongyang can do about it, said Marcus Noland, a North Korea expert at the Peterson Institute for International Economics in Washington.

The government would increasingly have to force people to provide goods and services to the state and get paid in won, added Noland, who closely studies the North Korean economy.

"It's been a tug of war for 20 years where the state would like to get control of the economy, to quash the market and to get everyone to use the North Korean won, but it just doesn't have the capacity to do any of those things," he said.

"It just makes it harder and harder for them to govern. Nobody wants what they're selling."

SECRET VIDEO

In the Chinese town of Changbai in Jilin province, just across the border from the hardscrabble North Korean city of Hyesan, one Chinese trader said North Korean officials he dealt with wanted yuan more than anything else, even food.

The yuan they earned from doing business quickly gets circulated into Hyesan, a city of roughly 190,000 people whose industry-based economy has slumped since the 1990s.

"The only thing they want is foreign currency," said the trader, who sells products including medicine and tea in Changbai. He declined to be identified because he did not want to jeopardize his business or endanger his North Korean partners.

In April, Daily NK posted video it said was shot secretly in February at an open-air market in Hyesan. The shaky footage showed vendors openly quoting prices in yuan for products like gloves and jackets, and one accepting payment in yuan.

Pyongyang has waged periodic campaigns to try to stop the use of foreign currency but with no success.

North Korea made circulating foreign currency a crime punishable by death in September 2012, the Paris-based International Federation for Human Rights said in a report last month.

Another group, Human Rights Watch, recently interviewed more than 90 defectors who had fled North Korea in the past two years about punishment they had received for economic crimes. None said they were penalized for using or holding hard currency.

Nevertheless, ordinary North Koreans are very careful.

"I have heard multiple stories of people hiding foreign money under the floorboards in the house, or burying it up the hill in the woods out back," said one person in northeastern China who has lived in Pyongyang and regularly interacts with North Koreans.

"Nobody puts it in the bank because nobody trusts the government."

THE WORTHLESS WON

Faith in the North Korean won crumbled when Kim's father, Kim Jong-il, ordered the sudden revaluation of the currency in November 2009.

The government chopped two zeroes off banknotes and limited the amount of old money that could be exchanged for new cash. The move, seen as an attack on private market activity at the time, spurred a rush to hold hard currency.

It also quickened inflation and according to South Korea's spy agency, sparked rare civil unrest in one of the world's most entrenched authoritarian states after North Koreans realized the won was not a safe store of value.

The government is widely believed to have executed the economic official who oversaw the revaluation.

Dollars have circulated in North Korea for decades, partly because of the cash siphoned off from official foreign trade.

The rise in the use of yuan is a more recent phenomenon and reflects a surge in trade and smuggling between North Korea and China along their 1,400 km (875 mile) land border, where a lot of the currency changes hands. Official trade with China is worth $6 billion annually.

Black market rates illustrate how far the won has fallen since the revaluation. It has plunged from 30 to one U.S. dollar to about 8,500, according to exchange rates tracked by Daily NK. The current official exchange rate is about 130 won per dollar.

Daily NK has sources in North Korea who report every fortnight on rates in Hyesan, the city of Sinuiju opposite the Chinese border city of Dandong and also the capital Pyongyang.

In border areas some 90 percent of transactions occur in hard currency, said Christopher Green, Daily NK's manager of international affairs. Elsewhere, foreign cash accounts for 50 to 80 percent transactions in private markets, he estimated.

INFORMAL ECONOMY EXCEEDS FORMAL - EXPERT

North Koreans increasingly did not refer to prices in won, Dong Yong-Sueng, senior fellow at the Samsung Economic Research Institute in Seoul, wrote in the April study on the use of foreign currency in the country.

Prices were marked in U.S. dollars for beer, university preparation courses and apartments, Dong wrote.

South Korea's central bank estimated foreign currency in circulation at $1 billion in 2000. Dong reckoned $2 billion in foreign cash was now sloshing around the economy. Around half was in U.S. dollars, 40 percent in yuan and 10 percent in euros, he told Reuters.

Dollars seeped into the market because trading firms exploited government quotas for exports and imports, making profits when prices diverged from those set by the state, Dong said.

It was not possible to estimate the amount of North Korean won in circulation, Dong added.

He said the North Korean informal economy was now bigger than the formal, state-led economy.

"Without foreign exchange, the economy would stop functioning," Dong said.

U.S. officials have previously accused North Korea of making extremely high-quality counterfeit $100 notes. This money is believed to have been used to raise real cash for the regime abroad rather than get cycled into the economy.

"JUCHE" IN NAME ONLY

Despite purporting to follow an ideology of "juche", or self-reliance, Pyongyang did not have the will to stop the circulation of hard currency even if it had the means to do so, said Yang Moon-soo, an expert on the North's economy at the University of North Korean Studies in Seoul.

Ordinary North Koreans wanted yuan while the elite preferred dollars, said Yang, who has carried out a study on the use of both currencies based on interviews with North Korean defectors.

One official at a European embassy in Pyongyang, who has been visiting North Korea for more than a decade, said the most noticeable change had been the increased use of yuan. Most shops carried prices in dollars, yuan or euros, said the official.

"People ... pay in yuan at the market for rice and other daily necessities," said Ji Seong-ho, a defector living in South Korea who stays in touch with friends in the North.

An estimated 70 percent of defectors in South Korea also send cash back to family in North Korea, according to the Organization for One Korea, a South Korean support and research institute on North Korean defectors.

A Reuters report last year showed how this money was getting to North Korea via underground agents in China, mostly Chinese of Korean descent. They use ties on both sides of the border to funnel around $10 million into the North each year, usually in yuan given the defectors send money to banks in China where it is collected by agents.

Use of the South Korean won is unheard of in North Korea. Even in the recently closed Kaesong industrial zone between the two Koreas, which employed 53,000 workers from the North, wages were made to a North Korean management committee in U.S. dollars, not the South's legal tender.

There are small signs some in the North Korean government may be coming to grips with the hard currency reality.

In the Rason special economic zone in the far northeast of the country on the border with China, the government-run Golden Triangle Exchange Bank changes yuan into North Korean won.

The rate - according to people who visited the bank recently - was 1,200 won per yuan, or 7,350 won per dollar. That's a long way from the official rate of 130 won for one dollar.