August 08,2008

New Regulations Dump Mandatory For-ex Purchasing to Curb Excess Liquidity

By CSC staff

The Chinese government has decided to loosen its foreign exchange management, and the requirement that companies should sell all their foreign exchange to appointed banks has been cancelled. The move is meant to ease the inrushing flood of foreign monies and relieve surplus currency liquidity. The actual effect of the new policy, however, is up in the air.

China released on August 6 the revised version of Regulations on the Foreign Exchange System, which also allow foreign companies to issue securities in China.

The Regulations on the Foreign Exchange System were first issued on January 29, 1996, and revised on January 14, 1997, at a time when China was short of foreign currency. After 11 years, it now holds the world’s largest foreign exchange reserve, exceeding $1.8 trillion in the first half of the year.

The huge reserve has led to a vast currency surplus in China. According to the original rules, most of a company’s foreign exchange earnings from selling goods or service must be sold to appointed banks within a set period, for which the government would have to issue RMB.

The State Administration of Foreign Exchange explained that the original regulations focused on controlling foreign exchange outflow, but now attention must also be paid to inflows. In fact, it is to relieve monetary pressure caused by inrushing foreign cash that the new regulations have been released.

These cancel the mandatory foreign exchange settlement of current accounts, and encourage firms to invest their funds in overseas markets. Actually the policies have been in effect since last August, but little has changed. Due to RMB appreciation expectations, foreign funds keep flowing in, much of it through suspicious trades. The exact amount of hot money inflow is in dispute.

Goldman Sachs economist Liang Hong said that as undervaluation of RMB is the cause, the new regulations were unlikely to relieve rampant foreign exchange inflows.

The new regulations contain requirements that foreign exchange receipts and disbursement of current accounts should be based on real and legal trades, and that fictitious trading would be punished, but any supervision with actual bite is questionable. Earlier this year, central government departments launched an inspection on foreign exchange inflow from the trade area, but companies complained bitterly about the inconvenience.

The new regulations reaffirm permission for foreign companies to issue securities in China, a yield of the third China-US Strategic Economic Dialogue, but investors don’t expect the policy to be implemented in the near future as the China Securities Regulatory Commission has issued no clear guidelines or policy related to it. China’s stock market, which will be affected by the policy, reacted by not reacting, though on August 7, the Shanghai Composite Index rose by 8.21 points to close at 2727.58, a rare increase theses days.

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