China Tightens Capital Inflows

$130 bil unintended capital inflow beyoned capital surplus and FDI ballooned central bank's foreign exchange. To counter the hot money, China changes its foreign currency policy: tightening inflow while relax outflow. Domestic companie can keep their foreign-currency income overseas and foreign companies can issue securities in China directly. Why we need currency exchange?..... BEIJING -- China announced changes to its foreign-exchange rules to address surging growth in its hard currency reserves, saying domestic companies can now keep their foreign-currency income overseas and pledging tougher penalties for illicit capital inflows. The new rules were announced late Wednesday and take effect immediately. They are part of a government effort to better regulate the flow of capital in and out of China's fast-growing and increasingly internationalized economy, while also moving toward a more flexible exchange rate mechanism for the Chinese currency. The U.S. Treasury Department welcomed China's move to significantly overhaul its foreign-exchange regulations. "The removal of restrictions on holding foreign exchange and allowing foreigners to issue securities in China are both positive steps in the development of China's foreign exchange and domestic financial markets," a Treasury spokeswoman said. China's stockpile of foreign exchange has mushroomed in recent years -- to $1.8 trillion at the end of June -- driven largely by a widening trade surplus and inflows of foreign direct investment. More recently, as the government has tried to slow the growing surplus by allowing its currency to appreciate -- making its exports more expensive -- officials have grown increasingly worried about large inflows of "hot money" from speculators betting that the yuan's value will continue to increase. The flood of foreign cash into China has contributed to inflation pressures, and fueled official concern that funds could rush out of the system if the economic situation reverses. The government hopes that stronger regulation of capital flows will enable it to continue to liberalize the yuan's exchange rate without increasing instability in its financial system. Wednesday's announcement "is one of several measures that will get them closer to the end result, which is full convertibility" of the yuan, said Paresh Upadhyaya, a senior vice president and currency-fund portfolio manager at Putnam Investments in Boston. "I do not think this is dramatic." The new revisions, issued by Premier Wen Jiabao, affect foreign-exchange rules last revised significantly in 1997, when China's international financial position was far less robust than it is today. The changes remove a requirement that Chinese companies bring all of their foreign-exchange income into the local banking system. By allowing companies to keep more foreign currency offshore, the rules could reduce inflows into China and potentially lessen upward pressure on the value of the yuan. In a series of questions and answers posted on a government Web site Wednesday, an unidentified official at the State Administration of Foreign Exchange said the revisions will also help enable foreign companies to issue securities in China. A Treasury Department spokeswoman welcomed the move, saying, "The removal of restrictions on holding foreign exchange and allowing foreigners to issue securities in China are both positive steps in the development of China's foreign-exchange and domestic financial markets." The revised rules will simplify approvals for Chinese companies seeking to invest overseas, the official said. At the same time, the government will step up monitoring of foreign-exchange fund flows, through measures such as on-site inspections and requiring banks to verify the legitimacy of currency transactions.