HONG KONG - China, which has long been concerned with restricting the flow of
funds out of the country, is now turning its focus on limiting speculative
inflows of capital looking for returns from the appreciating yuan.
Some economists, however, believe yuan appreciation is a better way to
alleviate the rising inflow pressures.
A series of changes to the foreign exchange rules, the first major alteration
to the regulations since 1997, were made this month, according to a statement
from the country's State Council, or cabinet. The new rules, in effect from
August 6, are expected to
stem the fast growth in foreign exchange reserves and improve the monitoring of
fund flows.
The State Council said the revision was also aimed at encouraging capital
outflows by simplifying the approval process for direct overseas investments by
Chinese companies and individuals. The revised rules allow domestic companies
to keep their foreign-exchange incomes abroad, compared with a previous policy
of compulsory repatriation.
They allow foreign companies more options - including the issuance of A shares
in domestic markets to raise capital, and letting domestic firms and
individuals invest directly in overseas equity markets under appropriate
approvals.
The new regulations allow authorities to check invoices to ensure that the
trade revenues are not being inflated as an excuse to bring unauthorized money
into the country.
Authorities are also now allowed to expand reporting requirements for financial
institutions to enhance monitoring of illegal capital inflows.
The authorities will impose fines of up to 30% of the capital involved in the
case of any unauthorized inward or outward foreign currency transfers; in
severe cases, the penalties could be more than 30%.
Economists said China switched focus in its foreign-exchange policy to checking
money inflows rather than outflows as the economy has been affected by rapid
growth in the amount of speculative money in recent years.
Since China removed the peg linking its currency to the US dollar in July 2005
and linked instead to a basket of currencies, a large amount of foreign capital
has flowed into the country to seek quick returns amid expectation of yuan
appreciation, higher interest rates and strong economic growth.
In the first seven months of this year, China's foreign direct investment
reached US$60.72 billion, up 44.5% year-on-year, while the number of newly
approved foreign investment projects dropped by 22.15%, the Ministry of
Commerce said last Wednesday.
The growth in FDI and the fall in the number of overseas-funded enterprises
established indicated that FDI is one of the major channels for short-term
speculative capital, or hot money, to rush into the mainland, Shi Lei, an
analyst at Bank of China, said.
"After entering China, such hot money often goes into real estate or the stock
market, pushing up asset prices, and also leads to higher inflation,
compromising the country's tightening monetary policy," Shi said.
Speculative capital is being channeled into fake projects, sham joint ventures
and shell companies, the National Development and Reform Commission said in a
statement on its website on July 18. The commission, the country's top economic
planning agency, warned that the stream of hot money not only caused risks to
its foreign exchange reserves, it threatened to jeopardize economic growth.
In the event of sudden outflows, such money flowing out could cause declines in
asset prices and lead to a financial crisis reminiscent of the 1997 Asian
financial turmoil.
China's foreign-exchange reserves, the world's largest, soared 35.7% to $1.81
trillion in the first half of this year, compared with 12 months earlier.
The yuan, which was trading at 6.86 against the US dollar on Tuesday, has
gained more than 6% against the US dollar this year. It has appreciated more
than 20% against the greenback since its peg to the US dollar was removed,
making Chinese exports less competitive in world markets. The yuan set a new
high against the US dollar, closing at 6.8113, on July 16.
Analysts said the new regulations were in response to the fast growth in
foreign reserves and not designed to slow the appreciation of the yuan, so it
would be a misunderstanding to believe Beijing has really changed its policy on
the yuan.
Claudio Piron and Yen Ping Ho, both for JP Morgan Chase Bank Singapore, wrote
in their research note on August 7 that the changes will help address the
severe external imbalance of the economy, though the net impact on flows,
reserve accumulation and appreciation will likely be a marginal rather than
marked deceleration in a backdrop where external inflows are still very much
driven by real trade and investment inflows.
"The knee-jerk impact could keep [the US dollar/yuan] supported ... The focus
must remain on the policy balance between inflation, growth and excess
liquidity. This implies [yuan] appreciation should remain on track [albeit at a
slower pace]," they wrote.
Hong Liang, an economist with Goldman Sachs, said that to the extent "these
policy changes help facilitate freer capital and trade flows, we see them as
positive steps towards building a more market-based economy in China".
However, "The fundamental driver behind China's massive and rapidly rising net
foreign-exchange inflows (about close to US$600 billion last year) has been the
undervalued [yuan]. Therefore, without getting the [yuan] right, the
[foreign-exchange] inflow pressures and the associated domestic inflation
pressures (as well as other distortions) are unlikely to be fundamentally
alleviated."
In a bid to curb speculative inflows, the State Administration of Foreign
Exchange, the currency regulator, started to inspect exporters'
foreign-exchange settlements from July 14 and is drafting regulations to
control cross-border payments for services.
Olivia Chung is a senior Asia Times Online reporter.
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