CBA: Tighter FX controls in China should slow, but not stop, capital outflows from the country

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China’s currency, the yuan, is on the nose with investors, even with the modest bounce that’s been seen in recent days.

Amidst expectations for further US dollar strength, largely built upon optimism over what US president-elect Donald Trump will deliver to the US economy in the years ahead, the yuan has copped a beating in 2016, losing 6.5% against the greenback.

It’s now fallen 13% over the past three years.

USD/CNY Weekly Chart

And many expect that trend will continue, leading many Chinese investors to swap their yuan into other currencies to protect against further losses.

Trillions of yuan have already been converted into foreign assets, and with the prospect for further US rate hikes arriving in the year ahead, there’s concern that this figure could grow rapidly if left unchecked.

Policymakers in China are clearly concerned about the prospect of even larger capital outflows, potentially laying the foundation for financial instability should it continue.

Source: CBA

In response to renewed weakness in the yuan, partially driven by speculative forces, China’s State Administration of Foreign Exchange, or SAFE, have announced a range of measures over the past week designed to slow capital outflows.

We Lei, China and Asia Economist at the Commonwealth Bank, has been looking at all the changes that have recently been announced, assembling this nifty five-point list as to what and who they’ll affect.

For clarity purposes, Li says Chinese people were previously allowed to purchase up to $US50,000 (or an equivalent amount of FX) per calendar year for current account purposes easily.

However, following the changes announced in recent days, the new FX purchase ensure people only buy the USD for their own genuine consumption needs, rather than for investment purposes.

Here’s the list:

1. The $US50,000 FX quota is strictly for one’s own use, and cannot be lent to others. Previously, if one needed more than $US50,000, he/she could ask his/her relatives or friends to purchase USD under their quotas and then pool the money together.

2. The updated FX rules stress that people cannot purchase FX for overseas investment, including buying houses, securities or investment type insurance. The FX quota allocated to Chinese individuals is strictly for current account transaction purposes (such as buying goods or services). While such requirements are not changed, the re emphasis increases people’s awareness of their legal obligation.

3. Much more information about the FX transaction is required to be submitted to the regulators. For example, the new FX rules ask people when the FX will be used. And if not used accordingly, one needs to fill another application or risk being put on a watch list for suspicious transactions. We think this new rule aims at preventing people simply switching CNY savings into USD savings (which is not a current account transaction).

4. Under the new FX rules, individuals who fail to comply could face cancelation of his/her FX quota for up to three years, effects on one’s credit record, heavy fines, or even criminal charges. Even though we think some of these proposals are difficult to implement in practice (except on those involved in underground banking activity), it should nevertheless have an impact in the short run, discouraging Chinese people converting CNY into foreign assets.

5. Last but not least, from 1 July 2017, banks are required to report to the PBoC any individual who conducts daily transactions at or over (1) $US10,000 in cash or cross the border transaction, (2) CNY 200,000 in cross the border transaction, (3) CNY 500,000 in domestic transaction, or (4) $US100,000 in domestic transaction. These restrictions should allow regulators to better monitor and prevent people borrowing FX quotas from others or sending money out of China via unauthorised channels.

As a result of the tighter regulations, Li suggests that this should limit capital outflows in the short-term, estimating that it could save China about $US50 billion of FX reserves this year, or about 12% of the total capital outflows seen in 2016.

However, he doesn’t believe it will succeed in completely eliminating capital outflows, suggesting that they will likely persist because of prospects of further strengthening in the US dollar.

“China’s fight against capital outflows will not be easy,” he says.

“The impact is unlikely to last given the strong structural demand by Chinese people to diversify their assets.”

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