HONG KONG - China's foreign exchange
regulators, after smashing more than 30
underground banks with 10 billion yuan in illegal
funds last year, have pledged tighter supervision
and management of cross-border capital flows.
The foreign exchange regulator, the State
Administration of Foreign Exchange (SAFE), said
this month it will step up checks on cross-border
capital flows, particularly on how foreign
currency is sneaked into the country and converted
into yuan and how such funds are spent, according
to the Financial News.
Last year's haul
compared with 70 underground banks involving
illegal funds of US$3.03 billion in 2006,
according to SAFE figures.
The growing
scale of underground banks was threatening
to
damage
the mainland's financial stability, SAFE's
Administration and Inspection Department director
Xu Mangang was quoted by Financial News as saying
at a conference this month.
"Besides, it's
becoming obvious that the funds that flow into the
mainland or flow out overseas were mainly placing
their bets on stock and property markets, having a
greater impact on the economies of the countries
or regions involved," he said. "The companies
involved in such illicit activities are of great
variety."
Last June, an underground bank
in Shenzhen allegedly run by a Hong Kong woman, To
Ling, was smashed. To’s money-exchange shop had
handled more than 4.3 billion yuan in illicit
money transfers between Shenzhen and Hong Kong
between 2006 and May 2007, China Central
Television (CCTV) reported in November.
About 130 million yuan had entered the
property market, and another 105 million yuan had
entered the capital market, the report said.
To's clients came from across the 31
mainland provinces and included units of
PetroChina, China’s largest oil producer, and
China Petroleum & Chemical Corp (Sinopec), the
nation’s largest fuel distributor, according to a
follow-up report by the Economic Observer
newspaper.
The government goals in
cracking down on cross-border capital flows are
twofold: it wants to stem illegal inflows of
short-term capital as it tries to balance its
international payment position, while seeking to
meet the needs of local institutions and
individuals holding and using foreign currencies,
Xu said at the meeting.
To redress its
trade imbalance, which helped to increase the
country's foreign exchange reserves 43.3% last
year to US$1.53 trillion, China scrapped limits on
companies converting current account foreign
exchange holdings into yuan last August, which
means they can now hold all foreign currency
revenue from trade instead of converting most of
it to the mainland currency.
At the same
time, it is letting the currency appreciate after
dropping a peg to the US dollar in July 2005 and
tying the yuan to a basket of foreign currencies.
The yuan, which rose 6.5% against the US dollar
last year, has gained more than 13% since the peg
was dropped.
The stronger currency has
helped to pull in increasing amounts of cash
inflows, although declines in mainland shares from
record highs in October has led to a fall in "hot
money" coming into the market.
China
received about US$550 billion in foreign exchange
inflows last year, according to Stephen Green,
head of research, China, at Standard Chartered.
Unexplained inflows, including securities flows
and trade finance and hot money - the main concern
of many People's Bank of China officials - was
US$87 billion, compared with US$320 billion in
2006.
"But what is important to note is
that unexplained flows ballooned in the first and
second quarters of 2007, just as China’s stock
market was going gangbusters," he wrote in his
research note on February 11. The Shanghai
Composite Index, which tracks yuan-denominated A
shares and hard-currency B shares, gained 40% to
3,820.7 in the first six months last year.
"In recent months, the unexplained flows
seem (and we emphasize that word) to have been
running at only US$3 billion a month. The stock
market seems to have been the key driver here,"
Green wrote. "We think hot flows are primarily
driven by the yuan appreciation expectations and
asset prices, rather than the US-China interest
rate differential. In other words, raising rates
now is not going to be a significant driver of
large additional inflows."
Money usually
finds ways of moving when it wants to go
somewhere, and it was hard to prevent such
movement. on the other hand, Green told Asia Times
Online by e-mail. "There are already quite a few
costs involved for money in/out flows and it is
not easy for retail money. The best thing to do in
these circumstances is to solve the fundamental
problem - the currency. Once that reaches an
equilibrium value then the hot money problem will
disappear."
Guo Tianyong, a professor at
the Central University of Finance and Economics,
said the best way to stem illegal inflows of
short-term capital was checks on cross-border
capital flows under the joint efforts of the
mainland’s banking and foreign exchange
regulators.
Cao Honghui, an economic
researcher with the Chinese Academy of Social
Sciences, said illegal flow of funds were behind a
large amount of cash withdrawals from banks in
Shenzhen and Guangdong since 2001. Half of the
195.6 billion yuan in cash withdrawals from
mainland banks in the first nine months of this
year came from branches in Shenzhen.
Cao
said if the issue of illegal fund outflows is not
handled properly, financial stability on both the
mainland and Hong Kong will be affected.
The fund outflows to Hong Kong were held
to account in part for a jump in share prices late
last summer, when in barely 11 weeks the Hang Seng
Index surged 53% to a record 31,638 on October 30
from 20,672 on August 16. The benchmark has since
tumbled by about 25% to around 23,714.
"While clamping down on the illegal flow
of funds that enter Hong Kong via underground
financial institutions based in neighboring
Shenzhen, the government should open more channels
to cope with the needs of local institutions and
individuals holding and using foreign currencies,
such as ‘the through train scheme,'" Guo said,
referring to a proposed scheme to allow individual
mainland Chinese to invest directly in the Hong
Kong stock market without a capital limit.
SAFE announced on August 20, 2007, that a
trial run of the scheme would be launched in
Tianjin, southeast of Beijing. The scheme has
since been shelved indefinitely after Premier Wen
Jiabao said in early November that further studies
should be carried out on the proposed scheme.
Olivia Chung is
a senior Asia Times Online reporter.
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