December 24, 2015 7:00 am JST
Globalizing the yuan

Beijing's policies create gap between perception, reality

HONG KONG/SHENZHEN, China -- Beijing's drive to internationalize its currency has stirred excitement about new financial opportunities. But by maintaining strict capital controls, the government may be setting businesses up for disappointment.

     The International Monetary Fund on Nov. 30 decided to add the yuan to the currency basket that underpins Special Drawing Rights, the fund's reserve asset. For China, which has been striving to take its currency global, this was a milestone. Yet the flow of yuan across the Chinese border is likely to remain tightly restricted for the foreseeable future. Zhou Xiaochuan, governor of the People's Bank of China, said he supports keeping necessary capital controls in place, even though the central bank intends to proceed with capital liberalization by 2020.

     The government may not like it, but among Chinese there is tremendous demand for moving money out of the country. Over the years, people have come up with numerous ways to circumvent the rules. Underground banks are one example.

Spot the teller

The term "underground bank" conjures up certain images that may be misleading. In China, even a regular street merchant can be part of an underground financial network.

     This was the case with a vendor at a pedestrian mall in Shenzhen, Guangdong Province. Amid rows of clothing shops for young people, the vendor, a woman in her 50s, sat on a plastic chair next to a sign advertising watch repairs. Her real job was to serve as a teller for a banking ring. "We can send money overnight if it's less than 300,000 yuan ($46,307)," she said.

     Massive amounts of money flowed out of mainland China this summer, when the nation's capital market was rocked by steep declines in stock prices and the government's devaluation of the yuan. The exodus far surpassed what could have exited through official channels. In principle, large sums can only be sent abroad to settle trade deals.

     Put another way, underground banks made the capital flight possible. They use a range of tricks, from forging trade documents to physically carrying cash into Hong Kong. Once the money is there, it is a cinch to send it overseas.

     Knowing full well how people were evading the capital controls, the Ministry of Public Security announced a crackdown on underground banks in August. In November, the authority ensnared an underground bank in Zhejiang Province, which had illegally sent more than 410 billion yuan abroad. This bank had conducted over 1.3 million transfers, many of them exceeding 1 billion yuan.

In a bind

The government's conflicting goals of globalizing the yuan and controlling capital have already put businesses in a tight spot.

     When an experimental free-trade zone opened on the outskirts of Shanghai in 2013, foreign companies set up shop in anticipation of more relaxed regulations concerning investment, finance and trade. Today, many of those companies are confused and frustrated.

     Consider the case of Mitsui Mining & Smelting. Two years ago, the company started using the yuan to settle transactions between Japan and China, rather than the yen. Yet it has been unable to set up a system that would enable group companies to use the Chinese currency when settling cross-border accounts. This is because Chinese regulations do not allow bank accounts to go into overdraft, meaning Chinese subsidiaries could fall into default.

     One foreign financial institution established a joint venture in the Shanghai zone, looking to sell international financial products to wealthy Chinese individuals. The venture has been "unable to make a move because the details of the framework for liberalizing overseas investment by individuals have yet to be finalized," a company executive said.

High hopes

Nevertheless, businesses around the globe are still jazzed about the opportunities a liberalized yuan could bring. 

     On the day of the IMF decision, former New York City Mayor Michael Bloomberg and others announced plans to create an organization to help realize yuan-denominated trading and settlements in the U.S. Participants include the U.S. Chamber of Commerce, as well as Goldman Sachs and other major financial institutions. The organization is co-chaired by two former U.S. treasury secretaries, Henry Paulson and Timothy Geithner.

     The U.S. government had been reluctant to add the Chinese currency to the IMF basket, but the American financial sector was worried about missing out on the yuan's inevitable emergence. Beijing had previously struck deals to encourage yuan trading in London, Toronto and other international financial hubs. 

     Unless the Chinese government loosens its capital controls, however, the widening gap between expectations and reality could prove problematic. 

(Nikkei)

Mitsui Mining & Smelting Co., Ltd.

Japan

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