China's Record Capital Outflows Put Tobin Tax Back on the Agenda

  • Levy studied as a way to reduce large cross-border flows
  • Foreign reserves are tumbling as PBOC supports the yuan

China has for the second time this month raised the possibility of taxing foreign-exchange transactions as record capital outflows from the world’s second-largest economy put pressure on the yuan. 

QuickTake Capital Controls

"We are currently studying measures including Tobin Tax, unremunerated reserve requirement and handling fees for foreign-exchange trading to suppress any abnormal and significant flows of short-term funds that seek arbitrage," Wang Xiaoyi, deputy administrator of the State Administration of Foreign Exchange, said Thursday at a press conference in Beijing. Central bank Deputy Governor Yi Gang called for such punitive measures to be introduced to deter currency speculators in China Finance magazine, a People’s Bank of China publication.

The last time SAFE said it was considering imposing a levy on yuan trading was in early 2014, when the authorities were having to stockpile dollars to prevent fund inflows from driving the yuan up too sharply. The tide of money has since turned and the nation’s foreign-exchange reserves tumbled $329 billion in the first nine months of this year, having been little changed in 2014 and jumped by a record $510 billion in 2013. 

"A Tobin tax is useful in curbing short-term capital outflows, but won’t benefit the yuan trading in the long run, as high-quality capital might find investing in the currency more expensive," said Liu Jian, a Shanghai-based researcher specializing in cross-border capital flows at Bank of Communications Co. "The key is to improve fundamentals. As the economy stabilizes, depreciation pressures will be reduced and then arbitrage flows will be smaller naturally."

Exchange-Rate Gap

China’s capital controls mean the yuan is valued differently in Hong Kong’s offshore market than it is in Shanghai, creating a profit opportunity for arbitrageurs that are able to move funds between the two cities. At current exchange rates, the currency is 0.4 percent weaker in Hong Kong than in the domestic market, encouraging outflows. The discount widened to more than 2 percent on Aug. 12, a day after the central bank devalued the yuan, and subsequently narrowed as PBOC intervention helped to stabilize the exchange rate.

The valuation gap’s days may be numbered though as China’s leadership is said to be considering a pledge to liberalize the nation’s capital account by 2020. The commitment would be in the five-year plan for 2016 to 2020, replacing a prior reference to “speed up” reforms in this area, according to a person familiar with the discussions.

Capital outflows from China climbed to a record $194.3 billion in September, exceeding the previous high of $141.7 billion in August, according to a Bloomberg estimate that also takes into account decisions by exporters and direct investment recipients to hold funds in dollars. A gauge of foreign-currency assets held by Chinese financial institutions, including the central bank, declined by the equivalent of 761.3 billion yuan ($120 billion), also a record, official data showed Friday.

The so-called Tobin tax was named after Nobel Laureate economist James Tobin, who first proposed such a levy in 1972 after U.S. President Richard Nixon’s decision to abandon the dollar’s peg to gold pushed up global volatility. The tax has in the past been rejected by economies from Europe to South Korea because of the risk investors will simply take their business elsewhere.

China has already announced some measures to curb yuan speculation. The PBOC in September asked financial institutions to set aside 20 percent of yuan forward contract sales in reserve for a year with zero interest, while the State Administration of Foreign Exchange has told banks to conduct special checks on currency trading under capital accounts.

The yuan was little changed Thursday at 6.3486 per dollar as of 2:12 p.m. in Shanghai, having strengthened 1.6 percent since sinking to a four-year low on Aug. 12. Capital outflows are slowing, while demand and supply for foreign exchange are basically balanced, SAFE’s Wang said.

— With assistance by Tian Chen

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