China ‘stuck’ as rigid controls on capital outflows becoming harder to peel back
- China imposes a strict capital account system to control the yuan exchange rate, its international balance sheet and the size of foreign exchange reserves
- But the regime comes with risks, analysts say, including distorting supply and demand in the foreign exchange market and restricting investment in some areas
China’s onerous capital account controls were all too apparent for Oziter Mao during a recent trip to a state bank.
“It was so troublesome to transfer just a few thousand yuan out of China to Australia,” complained the mainland resident, who is preparing to travel overseas. “You need to pay a three per cent ‘administrative fee’, and there are requirements for the documents.”
Every Chinese individual is entitled to buy US$50,000 worth of foreign currencies per year, but capital controls have been tightened in recent years through operational details, new documentation to prove the purpose of exchange, and ad hoc reasons to reject large-scale transactions.
Yu Yongding, one of China’s most prominent economists, said last May that he had tried to buy US$20,000 and remit the funds abroad, but was rejected by his bank because he was above 65 years old – a policy that does not officially exist.
Capital controls are endorsed by the International Monetary Fund as legitimate measures to stem the exodus of money and a plunge in the value of a currency.
Almost all countries and regions have control measures in place to prevent illegal activities such as money laundering and terrorism financing, and banks across the world are vigilant about processing cross-border payments and foreign currency cash.
While China’s capital account measures are also intended to stem illicit cross-border money flows, the system tends to discourage legitimate outflows and encourage inflows.
In the past year, the yuan has been one of the most stable currencies in the world with its exchange rate fluctuating around seven per US dollar; the country’s foreign exchange reserves have remained at about US$3 trillion; and China’s balance of international payment showed a healthy match of inflows and outflows.
However, analysts said this stability is achieved at the cost of distorting supply and demand in the foreign exchange market.
Michael Every, head of financial markets research Asia-Pacific at Rabobank, said China’s foreign exchange regime, which relies upon administrative controls, was “inherently fragile”.
“China is finding itself stuck in a paradigm, creating more and more problems and more and more side effects,” Every said. “Yet there’s no easy way to remove those controls … that would be a disaster as all of China’s money would leave China instantly and its currency would collapse.”
It is exactly what the State Administration of Foreign Exchange is trying to prevent. Pan Gongsheng, the director of the foreign exchange regulator, said the agency would manage foreign exchange risks from a political perspective.
“Unswervingly preventing systemic financial risks should be a bottom line to safeguard the nation’s financial security,” Pan said in a statement.
In foreign exchange, China rolls out the red carpet for those who can bring in hard currencies, but restricts residents and businesses from making overseas financial or property investments.
Some Chinese private firms that have made aggressive overseas investments, including Wanda, HNA and the company formerly known as Anbang Insurance, have been forced to offload overseas assets and repatriate funds.
There are a limited number of open financial channels for Chinese citizens, one of which is the Stock Connect programme that allows people to invest in stocks traded in Hong Kong. But even there, the accounts remain in the mainland where there is no risk of capital flight.
At the same time, China has repeatedly pledged to make it easier to process foreign exchange transactions for legitimate trade and investment purposes. Pan on Monday held talks with China delegates from Samsung, BMW and Microsoft, vowing to solve any relevant issues they had.
But even if China can ensure smooth foreign exchange transactions for legitimate purposes without interrupting imports, the controls can still backfire in other areas, analysts said.
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“The cost of capital controls is that money is not able to flow to sectors that can generate the best returns, therefore resulting in lower-than-expected investment,” said Khoon Goh, head of Asia research at ANZ Bank. “Restrictions on sectors mean more investment and competition are not able to take place.”
While China is still pursuing a convertible currency, Beijing is set to become more cautious as the US threatens to sanction Chinese banks and delist Chinese companies from US stock markets. Both could make Beijing more worried about the loss of hard currencies.
“China is just getting deeper and deeper into a hole as it is becoming extremely political,” Every said.