China has tightened its capital controls, in a sharp reversal of its market liberalising rhetoric, as it struggles to contain the fallout from last month's devaluation of the renminbi.
The August 11 devaluation unleashed turmoil on global stock markets and policy confusion at home, forcing the central bank to spend up to $200bn to support the currency. The prospect of an interest rate rise in the US has further encouraged capital flight.
The State Administration of Foreign Exchange (Safe), the unit of the People's Bank of China in charge of managing the currency, has in recent days ordered financial institutions to step up checks and strengthen controls on all foreign exchange transactions, according to people familiar with the matter and an official memo seen by the Financial Times.
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The Safe has ordered banks and financial institutions to pay particular attention to the practice of over-invoicing exports, used to disguise large capital outflows. The administration confirmed the existence of the memo, but declined to comment further.
China has long imposed limits on the amount of foreign exchange that can be bought or sold by individuals and companies, but those controls have broken down somewhat in recent years as the renminbi has become more widely used around the world.
Wang Tao, chief China economist at UBS, said the government had been expected to tighten some FX controls. But she added that relying on them exclusively to protect the renminbi "will not be viable over the long term and hence is unlikely to be pursued by China's central bank for long".
The policy reversal comes after China's central bank drew heavily on its vast foreign exchange reserves to prevent the renminbi falling dramatically against the dollar in the wake of the technical devaluation last month. Although still the largest in the world, its reserves fell by the biggest amount on record in August, dropping $94bn to about $3.56tn.
For the first time since it began internationalising its currency a few years ago, the central bank has also been intervening heavily in the offshore renminbi market to narrow the gap between the onshore (CNY) and offshore (CNH) exchange rates.
Analysts and people familiar with the matter say Beijing has spent up to $200bn defending the currency, but the net impact on the reserves is disguised by fluctuating valuations of reserve assets and other inflows into the reserves.
"They have gone from a credible peg that cost them almost nothing to a weak peg that nobody believes and that is costing them more than $10bn a day to defend. They're paying huge sums for something they had for free just a few weeks ago," said one person with close ties to China's central bank.
Within the government, the decision to move on the currency so soon after the bursting of an enormous stock market bubble is now widely regarded as a policy misstep.
The opacity of the Chinese system and the unwillingness of the authoritarian Communist party to explain its policy decisions to global investors or the Chinese public added to the market turmoil in recent weeks.
In another move to lighten its burden of defending the currency, the central bank informed banks last week that it would soon impose a new 20 per cent reserve requirement on all currency forward positions, in a move aimed at reducing heavy speculation on continued renminbi devaluation.
All market participants will be required to deposit the equivalent of 20 per cent of their forwards book with the central bank for one year at zero interest.
This will considerably increase the cost of currency hedging for Chinese companies, which had a total of $1.2tn in outstanding foreign currency debt by the end of March and are widely expecting further devaluation in the renminbi.
Additional reporting by Christian Shepherd