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China Imposes New Capital Controls

The State Administration of Foreign Exchange, China’s foreign exchange regulator, has imposed annual limitations on cash withdrawals outside China on China UnionPay bank cards, the Wall Street Journal learned on Tuesday. The limitations are reportedly contained in a circular SAFE, as the regulator is known, sent to banks.

Cardholders, under the new rules, may withdraw a maximum 50,000 yuan ($7,854) in the last three months of this year and a maximum 100,000 yuan next year.

Because UnionPay processes virtually all card transactions in China, the new limits apply to all Chinese credit and bank cards. Beijing already imposes a 10,000-yuan daily limit on withdrawals.

And why should the rest of the world care about how much money a holder of a Chinese credit card can get from an ATM in, say, New York? The new rules could be the first in a series of measures leading to draconian prohibitions of transfers of money from China.

Draconian prohibitions, in turn, could spark a global panic.

Capital has been flowing out of China at a fast pace for more than a year, but the rate has been accelerating recently. In August, for instance, the country’s official foreign exchange reserves dropped by a stunning $93.9 billion according to SAFE, the biggest fall on record. Some analysts, however, had expected Beijing’s cash hoard to plunge by $150 billion, and it’s possible SAFE has underreported the outflow to avoid creating alarm.

Yet it’s hard for Chinese leaders to mask the situation. Wind Information, China’s leading financial data provider, says money is coming out of the country at the rate of $135 billion a month, net of inflow. That assessment appears more or less correct. Capital outflow in August, according to Bloomberg, was a record $141.7 billion, which topped July’s record of $124.6 billion. Goldman Sachs puts the August outflow at $178 billion.

The global financial community has been focusing on the wrong crisis in China. Beijing’s efforts to prevent the collapse of equity values by massive purchases of stocks have received wide publicity since early July, but these purchases do not pose an immediate challenge to China’s technocrats. They are, after all, using their own currency to acquire shares, and they can print as much of it as they like, especially because the country is in a general deflationary era.

What is critical however, is Beijing’s defense of the renminbi. The People’s Bank of China, the central bank, began devaluing the currency on August 11th in a move that continues to puzzle observers. In any event, the devaluation triggered a run. Chinese officials, therefore, had to mount a heroic defense of the renminbi.

The only way Beijing can support its currency is to sell foreign exchange, in most cases the dollar. Reporting by the Financial Times at the end of August suggested that China was selling dollars at the rate of about $20 billion a day for this purpose. At that “burn” rate, Beijing could use up all its foreign exchange reserves in a year.

The outflow of forex is offset by investments and trade surpluses, but as investment returns decline along with confidence in China’s slowing economy and clumsy government, the outlook for accumulation of foreign exchange does not look promising.

In view of the situation, Chinese leaders have apparently felt compelled to protect their foreign cash. On September 17th, SAFE, citing “panic,” tried to inhibit outbound transfers of cash. The move, however, was merely a signal, in the form of calming words, from a senior official of that regulator. SAFE’s soft touch obviously did not work. This week’s limitation is a concrete step stopping money transfers that once were legal.

Beijing now finds itself in what looks like a no-win situation. If it does nothing, cash will continue to gush out of China.

If, on the other hand, China acts to stem the outflow, it could make an already bad situation worse. Actions that are too radical can create a panic. Moves not radical enough will probably hasten outflows because holders of cash will think they have only a limited opportunity to transfer their wealth to safer jurisdictions.

At this late date, confidence is eroding quickly, and China’s technocrats are finding their options narrowing and prospects dimming. 

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