China tightens capital controls to reduce depreciation pressure on yuan

BOFIT Viikkokatsaus / BOFIT Weekly Review 2016/49

China has recently tightened considerably its capital controls. At the start of this month, the State Administration of Foreign Exchange (SAFE), which operates under the People’s Bank of China, announced that any transaction exceeding $5 million must be declared to its vetting. The previous limit was $50 million. The chambers of commerce in China of the United States and the EU reacted quickly, noting that the new rule imposes a burden on foreign businesses operating in China. European firms said this week that they have recently been unable to repatriate dividends from China. Dividends are included in the current account, and under China’s international commitments, it should not restrict them.

China has also clamped down on oversight of capital movements to and from the Shanghai Free-Trade Zone, as well as tightened the rules on purchasing gold from abroad. Moreover, Reuters reports that corporate lending from China in yuan to foreign units must be reported to SAFE, which has imposed a ceiling on such lending based on the size of the firm. Thus, firms will no longer be able to transfer yuan abroad and then convert the money to other currencies. Media reports that additional measures are planned. More measures are expected to be introduced in coming months. The State Council, for example, is discussing a requirement that all “extra-large” investments abroad, i.e. exceeding $10 billion, will require top-level approval. Property investments of more than $1 billion by SOEs and direct investment projects outside the firm’s core business will also be scrutinised.

Officials have shown increasing willingness to go after attempts to circumvent capital controls when they suspect illegal activities are involved. For example, several illegal banks operating mostly in southern China were recently raided. Officials claim that the banks arranged unreported cross-border transfers worth tens of billions of dollars.

The tightened restrictions are designed to reduce capital flows out of China and diminish depreciation pressure on the yuan. The yuan’s exchange rate has weakened 3 % against the dollar since the end of September, but has strengthened nearly 1 % against the euro over the same period. China’s foreign currency reserves fell by $114 billion during October and November.

It is difficult to predict the impact of the new measures. Starting next month, private persons will be subject to a reset $50,000 annual forex quota. This might temporarily raise forex demand. Overall, at this stage of China’s development, it is difficult to use direct restrictions to stem capital outflows. Even if capital controls would temporarily reduce depreciation pressure on the yuan, they are at odds with China’s strategy of opening its markets to the world and promoting the yuan’s use in international trade. In the final analysis, these factors determine China’s economic success.

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