China eager to offset capital outflows by setting new rules for yuan conversion
A window has opened for China to increase yuan’s two-way float as policymakers are improving ways to manage market expectations
China’s foreign exchange watchdog has worked out a contingency plan to replenish the nation’s forex coffers, after the non inclusion of A shares in a global stock index dashed hopes for additional capital inflows.
Last Wednesday, the State Administration of Foreign Exchange (SAFE) said it was removing the time limit for conversion of external debt and income from capital account items raised in foreign currency to yuan. At the same time, the SAFE also decided to trim the number of items on the negative list of limited currency conversion activities.
In the past, only enterprises with foreign investment were allowed to exchange overseas remittances if it was for equity injections or shareholder loans.
“The revised regulation shows the eagerness of the SAFE to replenish the forex coffers after A shares failed to find a place in the MSCI,” said Iris Pang, senior economist of Natixis in Hong Kong.
Chinese officials and investors had been expecting the inclusion of domestic stocks in the widely tracked MSCI Emerging Markets Index, which would have brought in about US$400 billion (HK$3.1 trillion) of funds from asset managers, pension funds and insurers to the China’s equity market in the next decade.
But MSCI did not include A shares into the index and said China needs to further liberalise its markets for free capital flows and clarify the various legal implications.
According to official data, China’s foreign exchange reserves fell by US$27.93 billion in May to US $3.192 trillion, erasing the gains seen in March and April.
“Mainland non-government entities have raised US$139.3 billion from the offshore markets till date this year, with most of the funds being in US dollar. If we average out the US$139.3 billion into six months then the capital inflows each month was about US$23.2 billion,” Pang said in a research note.
She said the revised rules would partly offset the loss in forex reserves, as corporates would take advantage of cheaper exchange rate and shore up yuan holdings, especially when the yuan depreciates against the dollar.
“But it will not change the fundamentals of the weakening yuan,” Pang said.
Since most of the corporates raising funds from overseas markets needs the funds in the short term, there is very little chance of them retaining the yuan till it weakens further, Pang said. “Instead, they would take advantage of the short term depreciation of the yuan, which would lend stability to the Chinese currency in the longer term,” she said.
On the other hand, according to global ratings agency Standard & Poor’s, SAFE’s revised rules may spur Chinese companies’ offshore bond issuance and partly offset the pressures of capital flight.
“Under the new SAFE rules, all China-based corporate entities (except financial institutions) can repatriate the proceeds of their offshore bond issuances back to China and convert them to local currency,” a note issued by S&P said on Monday.
Before, the offshore issuances of Chinese domestic companies were largely limited to financing overseas investments but not for domestic projects.
Offshore bond issuances by Chinese companies dropped significantly in the first few months of 2016 from that of a year earlier, mainly due to falling interest rates after a string of rate cuts by China’s central bank and worries over the long-term depreciation and volatility of the currency.
However, following the SAFE announcement, Chinese companies now can choose when and how to use the proceeds of offshore bond issuances, including transferring proceeds back to the country.
Analysts said the Chinese authorities are learning to manage market expectations for yuan by leveraging varied policy tools, rather then simply tightening capital account controls.
“Now a window has opened up for the People’s Bank of China (PBOC) to increase yuan’s two-way float – yuan’s devaluation expectation is at the weakest in months, growth appears to be stable, housing price is up and US dollar is under pressure. Internationally, after being squeezed twice (in Aug and Jan), hedge funds appear reluctant to rush to short yuan,” said a report from BofA Merrill Lynch.
China Financial Times, the mouthpiece of the PBOC, published an article on Monday and said China should not use tightening of capital controls as a solution to reduce yuan depreciation pressures.
“The decision makers have a resolute determination to push for opening up and reform of the currency rate market…expanded two-way volatilities of yuan are inevitable…Instead of focusing on reducing volatility, regulators should try to formulate contingency plans,” the article said.