China Drafts Rules for Tobin Tax on Currency Transactions

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Will A Tobin Tax Help Curb Yuan Speculation?
  • Initial rate of levy may be kept at zero, people familiar said
  • The rules still need central government approval, they said

China’s central bank has drafted rules for a tax on foreign-exchange transactions that would help curb currency speculation, according to people with knowledge of the matter.

QuickTake The People’s Currency

The initial rate of the so-called Tobin tax may be kept at zero to allow authorities time to refine the rules, said the people, who asked not to be identified as the discussions are private. The tax is not designed to disrupt hedging and other foreign-exchange transactions undertaken by companies, they said.

Imposing a levy on foreign-exchange trading would be the most extreme step yet by policy makers to prevent speculative bets against the Chinese currency, after state-run banks repeatedly intervened to support the yuan and the government intensified a crackdown on capital outflows. A Tobin tax would complicate plans by China to create an international reserve currency and could undermine the leadership’s pledge to increase the role of market forces in the world’s second-largest economy.

“These measures can’t guarantee volatility in the market will come down since it’s difficult to identify if currency trading is down to speculation or the genuine need of companies hedging their foreign-exchange exposure," said Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd. "There haven’t been many successful experiences of this happening anywhere else in the world."

The rules still need central government approval and it’s not clear how quickly they can be implemented, the people said. The People’s Bank of China didn’t immediately respond to a faxed request for comment. PBOC Deputy Governor Yi Gang raised the possibility of implementing the punitive measure late last year in an article written for China Finance magazine.

The move comes before the yuan’s planned inclusion in the International Monetary Fund’s reserve-currency basket this October. Daisy Wong, a spokeswoman for the IMF in Hong Kong, wasn’t able to immediately provide comment.

The yuan has declined 4.5 percent since a surprise devaluation in August spooked global investors and spurred capital outflows. Bloomberg Intelligence estimates that $1 trillion left the nation in 2015, driven by a combination of capital flight, repayment of foreign-currency debt and purchases of overseas assets by Chinese citizens and companies.

Step Backward

"The levy will hurt market sentiment and make investors more panicked, as this shows that existing capital controls are not enough to curb outflows," said Andy Ji, a Singapore-based foreign-exchange strategist and economist at Commonwealth Bank of Australia. "Now is not a good time to roll out a Tobin tax as the market is already concerned about whether China will be able to increase capital account convertibility in the coming years, and this is another step backward to achieve that goal."

The Tobin tax takes its name from U.S. economist James Tobin, who in 1972 suggested taking a cut of foreign-exchange trades to limit currency speculation. History is littered with government attempts to extract revenue from financial transactions, not all of which were successful and most of which had unintended consequences.

Tax Disarray

The Eurobond market, now the dominant forum for corporate fixed-income transactions, came into being after President John F. Kennedy imposed a so-called interest-equalization tax in 1963 to make investing in foreign securities less alluring to U.S. investors and ease a balance of payments deficit.

Plans for a European tax on financial trades fell into disarray in December as member states argued about its impact on world markets. Brazil’s embattled President Dilma Rousseff has been pushing to revive a tax on financial transactions to shore up the government’s budget, though the proposal faces opposition in Congress.

The PBOC has been fighting to drive out speculators who take advantage of the difference in the yuan’s rates at home and abroad. The onshore gap with Hong Kong surged to a record 2.9 percent in early January before the PBOC cracked down by mopping up the currency’s supply offshore and restricting mainland banks from moving yuan overseas.

Government efforts to narrow the spread appear to be succeeding. The yuan traded in Hong Kong fell 0.25 percent to 6.5103 a dollar on Tuesday, trading around 0.04 percent stronger than the rate in Shanghai.

"The introduction of a Tobin tax will raise the costs of trading the yuan in the short term," said Ken Cheung, a currency strategist at Mizuho Bank Ltd. in Hong Kong. "It is quite surprising to see this news when the yuan is broadly stable."

— With assistance by Saijel Kishan, and Steven Yang

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