China Considers New Currency Tax

An analysis by Michael Lelyveld
china-bank-clerk-huaian-mar1-2016.jpg A Chinese clerk counts renminbi and U.S. dollar banknotes at a bank in Huaian, east China's Jiangsu province, March 1, 2016.

China's attempts to control market forces may be pushing it toward a new misadventure in currency policy.

Last month, Bloomberg News reported that China's central bank has been drafting regulations for a new tax on foreign exchange transactions to discourage speculation in the currency, the yuan renminbi (RMB).

The report, citing unnamed "people with knowledge of the matter," said the initial tax rate could be set at zero "to allow authorities time to refine the rules," presumably in preparation for raising the rates at will later on.

The plan for a "Tobin tax," named after Nobel Prize-winning U.S. economist James Tobin in the 1970s, contradicts China's repeated assurances that exchange rate pressures on the yuan and capital flight from the country have been slowing down.

On March 22, a top official of the State Administration of Foreign Exchange (SAFE), told a press conference in Beijing that depreciation pressure on the yuan "has largely been removed" and capital outflow "has eased significantly," the official Xinhua news agency reported.

Wang Yungui, director-general of SAFE's General Affairs Department, cited a relatively small loss of U.S. $28.6 billion in China's foreign exchange reserves in February after major monthly declines of some U.S. $100 billion in December and January shook markets around the world.

But Wang also confirmed that "authorities are studying the possibility of launching a Tobin tax," the official English-language China Daily reported on March 28.

It is unclear whether the easing of outflows is due to stabilization of the Chinese economy or numerous reports that SAFE has told banks to slow down money transfers and tighten capital controls.

"There appears to be a real crackdown on money flowing out of China," a partner at a Hong Kong law firm told The Wall Street Journal in early March. "Even normal business transactions which are ongoing are getting delayed."

The tax plan seems to be an additional sign of concern that the yuan and the reserves will not hold their values without intervention.

Bloomberg's sources gave assurances that the tax was not designed to prevent hedging practices used by companies to protect the value of trade and investment deals, but it remained uncertain how regulators would identify speculative exchanges in currency.

Impact on currency trading

The government has been on guard for months over reports that hedge funds have placed big bets on a major depreciation of the yuan since the People's Bank of China (PBOC) staged abrupt devaluations last August and again in January.

But analysts warned that even the threat of a tax on foreign exchange transactions could trigger capital outflows, as traders rush to beat the onset of new rules.

"If this keeps being talked about without going into effect, you'll have an artificially large amount of currency trading," said Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington.

"If it turns out that there's a large tax or a tax on some transactions but not others, then you'll absolutely get this kind of warped pre-tax trade," he said.

Scissors sees the tax plan as symptomatic of the government's fixation with control and distrust of market forces. The flawed policies backfired most recently in the stock market after authorities tried to impose controversial "circuit breaker" rules to avert big declines.

In January, share prices plunged on China's exchanges when regulators tried to control the selloff by suspending trading after limits on price changes were breached.

The suspensions led to pent-up selling pressure that only served to sow panic and even deeper declines.

On Jan. 7, the China Securities Regulatory Commission (CSRC) abandoned the circuit breaker rules, conceding it had "no experience" in how they should be applied.

On March 12, CSRC Chairman Liu Shiyu said the agency would not try to impose circuit breakers again "in the next several years," Xinhua reported.

"It all has to do with the fact that they don't like the way that the market's behaving, as opposed to actually having a plan for market reforms," Scissors said.

Last month, the market missteps took on political overtones in an open letter from unnamed "loyal Communist Party members" to President Xi Jinping, urging him to resign.

"In the economic sphere, ... your direct involvement in the development of micro- and macroeconomic policy has created instability in the stock market and property market, allowing the wealth of hundreds of thousands of ordinary people to vanish," said the letter posted on March 4 on the Canyu (Participation) and Wujie (Watching News) websites, as translated by China Digital Times.

Chinese homebuyers look at housing models of a residential property project in Yichang, central China's Hubei province, March 6, 2016.
Chinese homebuyers look at housing models of a residential property project in Yichang, central China's Hubei province, March 6, 2016.
Credit: ImagineChina
Frequent interference

While the government's interference with market forces has proved counter-productive, it has also been increasingly frequent.

Investors in China's stock markets have been whipsawed by rules on margin trading, financing and short-selling, which have changed repeatedly since share prices collapsed last year.

Uncertainties in both the markets and the currency stem from concerns about China's economy, which grew at the slowest pace in 25 years in 2015, although still at a relatively robust official rate of 6.9 percent.

Under its 13th Five-Year Plan, the government has targeted average annual growth of 6.5 percent through 2020.

But official assurances of more sustainable, less spectacular growth have been undercut by volatility in the government's economic and regulatory policies.

Recent claims of a turnaround in the troubled housing market appear to be another case in point.

In recent weeks, state media have returned to using terms like "booming" and "red-hot" for housing sales, while the ink is barely dry on stories of last year's slump and a five-year backlog of unsold homes.

Buying has been spurred by official reports of huge increases for new homes in first-tier cities like Shenzhen, where prices soared 57.8 percent in February from a year earlier, according to the National Bureau of Statistics (NBS).

Prices in February climbed 25.1 percent in Shanghai and 14.2 percent in Beijing from a year before, the NBS reported.

Last month, Shenzhen city authorities claimed an even higher 72-percent surge in home prices.

State media has credited government decisions to cut interest rates and down payment requirements for the turnaround in real estate.

New home prices rose in 47 of 70 large and medium-sized cities in February, up from 38 in January, the NBS reported last month. But the sudden jumps have already sparked warnings of another housing bubble.

At a press conference during last month's annual legislative sessions, Minister of Housing and Urban-Rural Development Chen Zhenggao denied that China was facing a bubble collapse like that of the 1980s in Japan.

In March, city authorities in Shenzhen and Shanghai re- imposed a series of restrictions including higher down payment requirements in an effort to keep speculation under control.

Despite the curbs, prices in March jumped another 5.1 percent in Shanghai from February and rose 3.6 percent in Shenzhen, China Index Academy reported last week.

But experts say smaller cities remain saddled with heavy inventories of unsold homes and unfinished property projects.

Last month, Yao Yang, dean of Peking University's National School of Development, urged the government to launch a massive buyback program in third and fourth-tier cities to house the poor, China Daily said.

Artificially inflated returns

The disparities appear to be another symptom of investors chasing artificially inflated returns, pumped up by frequent changes in government policies and market rules.

"This is all just liquidity sloshing from one place to the next," Scissors said.

In a China Daily commentary, Peter Fuhrman, chairman of China First Capital, argued that "the best way to cool China's housing market ... is to have more good and safe alternatives for people to invest in," like overseas mutual funds.

Instead, authorities have started cracking down on lending to finance down payments in overheated housing markets like Shenzhen and barring direct loans from developers.

Down payment loans in Shenzhen may have already reached 2 billion yuan (U.S. $306.9 million), raising default risks, China Business News reported last month.

The PBOC "will prohibit real estate brokerages and property developers from running financing services if they do not have relevant licenses," deputy governor Pan Gongsheng said.

But there are already signs that government intervention may interfere with attempts to cut China's staggering industrial overcapacity in the steel industry, which has become a focal point for restructuring the economy and reducing pollution.

In March, China Daily cited a slight uptick in steel prices and "the central government's destocking policy for the real estate industry" as factors that have temporarily brightened the outlook for beleaguered steelmakers.

"With steel prices rebounding and some manufacturers starting to see profits, an increasing number of factories are choosing to resume production," the paper said, citing China Business News.

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