China Evaluating Tax on Foreign Exchange & Capital Flows

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China’s Tobin Tax move could impact offshore RMB trading.

Jan. 6 –  China’s State Administration of Foreign Exchange (SAFE) – the regulatory body that oversees all movements of capital out of, and into the country has called for an “in depth study” on the potential imposition of a so-called “Tobin Tax” – a tax on all spot conversions of one currency into another. Named after the Nobel Prize winning economist James Tobin, the tax was originally meant to be used for curbing short term round trip excursions into another currency to prevent deliberate destabilization of national currencies being wrought by market traders.  China however seems to be evaluating its use as a means to control currency flows even as the Chinese RMB is being liberalized.

China’s SAFE is the world’s largest fund, controlling China’s Central Bank reserves of some US$3.7 Trillion.

Offshore RMB trading hubs such as London, Singapore and Hong Kong would be severely impacted by the introduction of such taxes since the clear intent would be to reduce turnover and limit disruptive capital flows. Yi Gang, Deputy Chief of the People’s Bank of China, has commented “Persistently guarding against cross-border liquidity flow shocks is the key to good foreign exchange management.” However, at the same time Yi has been known to promote the RMB as a free floating currency with its movement set by supply and demand, a contrary position.

There are concerns that “hot” money will pour into China on the back of financial reforms, yet would also leave when the mood turns. Asia has been hit over the past 20 years by a series of hot money crises and especially so during the Asian Financial Crisis back in 1997.

Wealthy Chinese are currently also moving their money away from China, usually via laundering it through Macau or smuggling it overseas. This typically carries a 20 percent premium ‘handling’ charge for using these routes. Should legal mechanisms be introduced to allow Chinese nationals to legally invest overseas, the capital outflows are likely to rise considerably.

The imposition of such taxes would negatively impact upon plans for the City of London to develop its RMB trading business, which was announced just last year in an apparent US$8 billion deal. That is now under threat in terms of the true scope of London’s ability to conduct meaningful trade in RMB.

Chris Devonshire-Ellis of Dezan Shira & Associates comments, “this should not come as any real surprise, the Chinese always guard their – and other people’s – money with utmost security. I expect to see some sort of tax imposition until the Chinese feel politically comfortable with global trade in their own currency. They have not yet been down this road before and it will take time for them to feel at ease with allowing the RMB to be free floating.”

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