China has released new rules to curb currency speculation amid signs that hot money inflows have helped push the yuan to a series of record highs in recent weeks. The rules tighten limits on long yuan positions that banks can hold for their own accounts and aim to discourage firms from using dollar loans as a means to speculate on yuan gains.
Regulators will also increase scrutiny on exporters who channel money into the country disguised as trade payments, according to the announcement from the State Administration of Foreign Exchange (SAFE) on Sunday. The changes suggest that "a level of tolerance over the nature of RMB appreciation has been breached," Paul Mackel, head of Asian FX at HSBC, wrote in a note to clients on Monday. The yuan has gained 1.2 percent in 2013, of which 0.9 percent has occurred since the beginning of April. Analysts and traders agree that heavy speculative capital flows have fuelled this rise.
The yuan fell by as much as 0.3 percent to 6.1768 per dollar at its low point on Monday afternoon, a big drop by the standards of China's tightly controlled currency, though it recovered to 6.1660 near the close. The new net open position limits apply to banks whose foreign-currency loan-to-deposit ratio (LDR) exceeds the reference rate of 75 percent for Chinese banks and 100 percent for foreign banks.
Moreover, the higher a bank's forex LDR, the more tightly its long yuan positions will be restricted when the new position limits take effect at end-June. The move should make foreign currency loans more expensive, as the rules incentivise banks to set aside more forex deposits against their loans. Onshore forex deposit rates may also rise, as banks try to attract more deposits.
"A lot of the RMB's recent strength has come from onshore, where domestics have been borrowing more in foreign currency and holding more assets in RMB," wrote Mackel, referring to the Chinese currency by an alternate name. "We have felt that these flows were adding to the hot money inflow pressures," he wrote.
Firms that earn revenue in yuan prefer to borrow in dollars if they expect the yuan to rise, because the loan becomes cheaper to repay in yuan terms. Forex loans outstanding rose by 10 percent in the first three months of 2013, official data shows. The system-wide forex LDR stood at 171 percent at end-March. That suggests most banks will be subject to the new rules.
China ran a capital and financial account surplus of $102 billion in the first quarter, up from $20 billion in the fourth quarter last year, reflecting the heavy capital inflows. In addition to strong demand from corporates betting on yuan gains, banks have also accumulated proprietary long yuan positions in an effort to profit from the trend, foreign exchange dealers say.
Policy banks such as China Development Bank, as well as banks whose forex LDR is already below the reference rate, are exempt from the new regulations. Many analysts expressed scepticism about China's export figures for March, suspecting that unusually high exports to Hong Kong may reflect companies inflating export invoices in order to skirt China's capital controls and convert more dollars into yuan.
SAFE said on Sunday it would hand down a risk warning notice 10 days after it finds that a firm's capital flows do not match physical goods shipments or if the firm is channelling unusually large amounts of money into China. Such companies will then be placed on the SAFE's B list, which is for companies that are more closely monitored, for three consecutive months and will only be moved back on the A list if all the relevant indicators return to the normal range.
Chinese exporters and importers often bring capital into or out of the country disguised under their trade accounts, and SAFE has launched regular campaigns against the practice. The Customs Administration is scheduled to announce April trade data on Wednesday. Exports in March grew 10 percent from a year earlier and imports rose 14.1 percent. SAFE said it would finalise the B list and send out the first batch of warnings before May 10.
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