China backflips on currency policy with controls to stem yuan’s outflow

China’s central bank will limit the amount of yuan that Chinese companies can remit outside the country, imposing a cap for the first time in more than two decades to stem the yuan’s outflows amid its 7 per cent decline this year.

Non-financial companies domiciled in China will be limited to lending the equivalent of 30 per cent of the owners’ equity to an overseas company in yuan, according to a November 26 circular by the People’s Bank of China, a copy of which was obtained by the South China Morning Post. Both the lender and the borrower must share an existing shareholding relationship, the document said.

Coming as the yuan had been plumbing daily lows this year, the latest control is a reversal of the government’s strategy of making the yuan a global currency to rival the US dollar, indicating that the monetary authority is willing to put its ambitions on hold for the sake of preserving stability.

“The logic behind the new measure is to drain offshore yuan liquidity because too many people are exporting yuan for currency swaps or for shorting the currency as a way of skirting domestic restrictions,” said Li Yimin, senior analyst at Shenwan Hongyuan Securities. “Previous controls were mainly aimed at controlling the yuan’s inflows to deter hot money. This time, the focus is on its outflows.”

With the new controls, banks will now ask Chinese companies to explain their purpose for remittances and offshore loans in yuan. Any remittance that raises suspicions will be suspended.

Banks can also suspend any remittances for companies whose offshore transfers surpass the 30 per cent limit.

The New York branch of Industrial and Commercial Bank of China had already stopped two cross-border payments due to the new rules and it expected more yuan remittances to be closely scrutinised or blocked, a bank official said.

China’s monetary authority has imposed a series of policies to stem capital outflows. On Monday, the Shanghai branch of the State Administration of Foreign Exchange said approval from the authorities was required for applications for cross-border payments exceeding US$5 million meant for overseas investment purposes, according to sources.

The government has also tightened checks on overseas acquisitions and imposed rules to make it more troublesome to bring yuan abroad.

With the new curbs, Beijing is shifting its emphasis from propping up the yuan’s value in the currency markets to blunt controls for taking it offshore.

“The offshore yuan market in Hong Kong has been shrinking, so some speculators are using yuan outflows as a way to short the currency,” said Aidan Yao, senior emerging Asia economist at AXA Investment. “The central bank has also been considering bringing the cross-border business of the larger lenders under stricter scrutiny as some of them have been using overseas lending and investment as a cover for capital flight.”

China’s net outbound yuan payments have reached 1.8 trillion yuan (US$261 billion) for the year to October while offshore yuan deposits declined by 255.7 billion yuan. That means yuan outflows may have become a way for Chinese companies to circumvent foreign-exchange controls, China International Capital Corp said on Monday.

The onshore yuan closed at 6.8949 against the US dollar on Thursday, 0.1 per cent weaker from Wednesday.

The central bank set the yuan’s daily reference rate at 6.8958 per dollar, 93 basis points weaker than Wednesday.