Photographer: Xaume Olleros/Bloomberg

China Tobin Tax Riles Analysts as Citi Warns of Foreign Exodus

  • Proposed levy seen curbing liquidity, deterring overseas funds
  • Mobius among minority of supporters, eyeing boost to reserves

China’s draft plan for a tax on currency trading is getting a cold reception in the foreign-exchange market.

Mizuho Bank Ltd. says the so-called Tobin tax on yuan transactions would reduce liquidity in a currency with bid-ask spreads already five times wider than those of the yen. A levy would set back China’s push to make the yuan a reserve currency and could heighten investor anxiety over capital outflows, according to Commonwealth Bank of Australia. The proposal is “short sighted” and would drive away foreign investors, Citi Private Bank said.

While opposition to the tax wasn’t unanimous -- Franklin Templeton’s Mark Mobius called it a “positive” move that will help bolster China’s foreign reserves -- the responses reflect growing concern that efforts to prop up the yuan could do long-term damage to the nation’s financial markets. Unprecedented government intervention in the Chinese stock market has led to a plunge in volumes, while failing to spark a sustained rally.

"A Tobin tax would be a big blow to China and it may backfire” if investors decide to dump yuan assets to avoid the levy, said Sean Yokota, the head of Asia strategy at Skandinaviska Enskilda Banken in Singapore. The proposal “would be moving completely in the opposite direction of letting markets set prices rather than the government," he said.

Liquidity Risk

China’s central bank has drafted rules for a tax on foreign-exchange transactions, a plan that still needs central government approval, people with knowledge of the matter said on Tuesday. The initial rate may be kept at zero to allow authorities time to refine the rules and to deter speculators by letting them know that there is a system in place, said the people, who asked not to be identified as the discussions are private.

QuickTake The People’s Currency

The People’s Bank of China has been fighting to drive out traders who take advantage of the difference in the yuan’s rates at home and abroad. The PBOC drove the currency’s offshore borrowing costs to records in January, increasing short-selling costs, and instructed banks on the mainland to restrict sending yuan overseas.

Among the biggest Tobin tax concerns cited by analysts is that the levy would sap market liquidity. One gauge of the ease of trading the yuan -- the currency’s bid-ask spread against the dollar -- was about 0.05 percent on average in March, versus 0.01 percent for the dollar-yen rate, according to data compiled by Bloomberg Intelligence.

Hedging Costs

"The Tobin tax should make investors more cautious on trading the yuan,” said Ken Cheung, a currency strategist at Mizuho in Hong Kong. “This will impose an adverse impact on market liquidity and development.”

The proposal 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.

While people familiar with the draft rules said they aren’t designed to disrupt hedging and other foreign-exchange transactions undertaken by companies, costs for those trades would probably increase anyway because more documentation will be needed to differentiate between hedging and speculation, said Charlie Chan, a former Credit Suisse Group AG proprietary trader who runs the $150 million Splendid Asia Macro hedge fund in Singapore.

Backward Step

Another risk is that investors would interpret a Tobin tax as a signal that capital outflows are still a major problem, said Andy Ji, a Singapore-based foreign exchange strategist and economist at CBA. 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.

"The levy will hurt market sentiment and make investors more panicked, as this shows that existing capital controls are not enough to curb outflows," Ji said. "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."

Mobius Positive

Not everyone thinks the tax is a bad idea. Mobius, the executive chairman at Templeton Emerging Markets Group, said in an interview in Kuala Lumpur that the move would help authorities stem a $790 billion slide in foreign-exchange reserves since June 2014. The PBOC has tools to address the tax’s impact on liquidity, such as adjusting banks’ reserve-requirement ratios, according to Banny Lam, co-head of research at Agricultural Bank of China International Securities Ltd. in Hong Kong, a unit of one of China’s largest state-run lenders.

“Targeting speculators is a good idea,” Lam said. “It will help stabilize the onshore and offshore markets, which will be good for the economy.”

Market reaction to the reported proposal was muted on Tuesday, with the yuan slipping about 0.1 percent against the dollar in both onshore and offshore trading.

It’s unlikely that China will end up implementing the tax, said Tommy Ong, managing director for treasury and markets at DBS Hong Kong Ltd., who cited a history of unsuccessful or aborted attempts to implement such levies in countries around the world. 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.

Side Effects

In the European Union, plans for a 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, but the proposal faces stiff opposition in Congress.

For Ken Peng, a Hong Kong-based Asia investment strategist at Citi Private Bank, a Tobin tax would just add to the list of reasons for foreign investors to avoid Chinese assets. Confidence in mainland markets has already been damaged by the government’s attempt to prop up equities, a campaign that has failed to prevent a 19 percent slide in the Shanghai Composite Index this year.

“A main side effect is that foreign investors just won’t participate the yuan market in the future,” Peng said. “Why would they invest in the yuan market when the economy is slowing, capital is leaving, and the system is getting more and more tightly controlled?"

— With assistance by Tian Chen, Saijel Kishan, and Kyoungwha Kim

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