China Clamps Down on Currency Flows

An analysis by Michael Lelyveld
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china-yuan-bank-huaibei-anhui-nov25-2016.jpg A Chinese clerk counts renminbi (yuan) banknotes at a bank in Huaibei, eastern China's Anhui province, Nov. 25, 2016.

China is plugging holes in its foreign exchange rules to keep its currency and reserves from sinking below key levels as worries about U.S. policies grow.

Regulators have been cracking down on all forms of capital outflow in an effort to keep the yuan from dropping below the psychological barrier of seven to the U.S. dollar while foreign exchange reserves approach the U.S. $3-trillion (20.6-trillion yuan) mark.

The twin defenses appear to be behind the Jan. 1 notice from the State Administration of Foreign Exchange (SAFE) requiring individuals to justify currency conversions, even within the legal limit of U.S. $50,000 (343,820 yuan) per year.

Under the new rules, banks have been ordered to report all transactions of over 50,000 yuan (U.S. $7,271), compared with earlier limits of 200,000 yuan (U.S. $29,085).

Citizens must sign a pledge that the funds "will not be used for overseas purchases of property, securities, life insurance or any other insurance of an investment nature," the official English-language China Daily reported.

Applicants must confirm compliance with money-laundering rules and other restrictions under penalties of losing the right to convert currency for three years and the threat of possible investigation, the paper said.

"These are not new rules. They are simply more stringent enforcement of the existing ones," China Daily asserted.

But the pledges and potential investigations may have a chilling effect on individuals who have been investing abroad to protect their savings against the falling value of the yuan, which depreciated against the U.S. dollar by about 6.5 percent last year.

The shrinking value of the currency has taken its cue from China's economy. Last week, the National Bureau of Statistics reported that gross domestic product growth fell from 6.9 percent in 2015 to 6.7 percent last year, the slowest pace in 26 years.

Surge in foreign deals

The targeting of individual transactions follows a November announcement by SAFE and three other agencies of plans to "tighten screening of overseas investment projects" following a 53-percent surge in foreign deals in the first 10 months of last year.

Outbound direct investment (ODI) by Chinese companies has dwarfed foreign direct investment (FDI) in China since late 2015, raising government concerns that capital is leaving the country as interest rates rise and the dollar strengthens in the United States.

China's non-bond ODI soared 46 percent last year to U.S. $170 billion (1.1 trillion yuan), according to an initial estimate by the China Global Investment Tracker, published by the American Enterprise Institute and the Heritage Foundation in Washington.

In the past week, the Ministry of Commerce reported similar results. Non-financial ODI jumped 44.1 percent last year to U.S. $170.11 billion (1.17 trillion yuan), while FDI of 813 billion yuan (U.S. $118.2 billion) rose only 4.1 percent, the ministry said.

The government has sent a series of signals that concern is rising over the net outflows.

In December, a People's Bank of China (PBOC) official announced an inter-ministerial effort with 22 government agencies to block illegal money transfers under the government's "One Belt, One Road" (OBOR) initiative for developing trade routes and infrastructure overseas.

PBOC Vice-Governor Guo Qingping said the crackdown was aimed at "combating the financing of terrorism regimes," but the enforcement coincides with attempts to halt capital flight through ordinary investment activities.

"Real estate and precious metal trading have become new avenues for such crimes, with internet finance and third- party payment channels dealing a further blow," China Daily quoted Guo as saying.

Government’s vigilance spreads

The government's vigilance has gradually spread from big investment deals to individual transactions with the growth in capital leaving the country.

"The move aims to fix loopholes in the current management and curb foreign exchange purchase violations and other illegal activities, such as fraud, money laundering and underground banks," said SAFE, as quoted by the official Xinhua news agency.

Last week, the agency that controls state-owned enterprises (SOEs) also announced new rules aimed at cutting capital outflow.

Under the rules, 102 large SOEs will be barred from investing abroad in sectors including real estate, iron ore, petroleum and non-ferrous metal, the State-Owned Assets Supervision and Administration Commission (SASAC) said, according to state media.

The Rhodium Group, a New York-based consulting firm, estimated that net outflows under the non-reserve capital account reached U.S. $379 billion (2.6 trillion yuan) in the first three quarters of last year.

The multi-front buildup of capital controls comes as China's foreign exchange reserves dropped in December for the sixth month in a row to U.S. $3.01 trillion (20.7 trillion yuan), raising concerns that the PBOC can't keep the yuan from falling below the seven-to-the-dollar barrier without slipping under the U.S. $3-trillion mark.

State media have stressed that both are only psychological thresholds while insisting that there are no new capital controls.

"Despite continued drops in China's foreign exchange (forex) reserves, economists believe there is no need to panic as reserves are still abundant for the country to fend off external risks," a Xinhua news analysis said on Jan. 9.

"Enforcing forex rules not currency control," said a China Daily headline on Jan. 5.

Last week, a SAFE official argued that China still has "ample" reserves, suggesting that the government may choose to break the U.S. $3-trillion barrier in defense of the yuan.

There is no need to "create excessive hype over a certain number," SAFE spokesperson Wang Chunying said, according to Xinhua.

A pedestrian walks past the headquarters of the People's Bank of China (PBOC), China's central bank, in Beijing, May 4, 2016.
A pedestrian walks past the headquarters of the People's Bank of China (PBOC), China's central bank, in Beijing, May 4, 2016.
Credit: ImagineChina
Currency concerns

The government's currency concerns are believed to be the reason behind the abrupt rise and fall of the yuan's value on the successive trading days of Jan. 6 and Jan. 9.

Currency speculators in Hong Kong were stunned on Jan. 6 when the PBOC's daily "fixing" of its central parity rate jumped by 639 basis points, or hundredths of a percentage point. The sudden rise against the dollar came after weeks of smaller declines.

The boost was accompanied by a spike in yuan overnight interbank interest rates to over 60 percent, making short trading positions against the currency indefensible.

The move was apparently orchestrated by the PBOC to punish speculators as part of an effort to stop the yuan's downward spiral. But the depreciation resumed on Jan. 9 when the PBOC's fixing fell by 594 basis points to 6.9262 to the U.S. dollar.

"Our impression is that the PBOC is very sensitive about the key 7.0 level for the yuan," said Liu Weiming, chief investment officer at Fu Xi Investment Management, according to The Wall Street Journal. "Once 7 is broken, people will expect 8 and it will get even worse."

But defending the yuan could become unaffordable if the PBOC treats the U.S. $3-trillion reserve level as equally inviolable. Tighter capital controls may be the only option.

"We're starting to see more and more of a negative cycle being created," Benjamin Fuchs, chief investment officer at BFAM Partners in Hong Kong, told Bloomberg News. Attempts to curb outflows are "just making people want to take money out quicker," he said.

Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington, said that China's capital outflows began with its anti-corruption campaign before economic troubles became the major motivation.

"That caused a lot of people to become quite frightened and they moved their capital abroad," Hufbauer said.

Cushioning the yuan’s fall

The PBOC has tried to cushion the currency's fall by buying yuan until its reserve levels suffered.

China's foreign exchange reserves hit a high of U.S. $3.99 trillion (27.43 trillion yuan) in mid-2014.

"By now, you have the psychology feeding on itself and people wondering if they can get out at all," said Hufbauer.

The PBOC has also been pushed into supporting the yuan by U.S. President Donald Trump's charges that China manipulates the currency's value to gain an export advantage.

"Then, other forces within the government said they can't continue to spend their foreign exchange reserves on this attempt to placate Trump," Hufbauer said.

"So, here you've got, I would say, kind of a mess going on," he said.

China's tightening of capital controls is unlikely to be what the International Monetary Fund had in mind when it approved the yuan's inclusion in its Special Drawing Rights (SDR) basket of major freely-traded currencies in 2015.

"I think the IMF decision was essentially political to begin with, so on political grounds, they will probably not say very much. But it's very troubling what's happened," Hufbauer said.


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