Policy Talking Points: Q&A on the Currency

来源: CHINA FOREX 2017 Issue 1

In an effort to gain a better understanding of the state of China's foreign exchange administration,the sharp swings in the value of renminbi and how do the foreign exchange reserves relate to renminbi internationalization,Debra Lodge,Managing Director Global Markets,Head of RMB Business Development North America interviewed Mu Zhiqian a former consultant to the State Administration of Foreign Exchange. That discussion follows in question and answer form.

Q: Many companies complain that China's management of foreign exchange is getting stricter regarding the conversion of foreign exchange and in making offshore remittances. There appears to be a huge gap between official pronouncements and actual practice. Banks are caught in the middle and criticized by both sides. Can you comment on this?

A: Thank you for your honest assessment of the situation. This shows confidence and strength on your part. Enterprises get first-hand experience on a daily basis from actual practice under our regulatory system. The predicament of the banks,which stand between the enterprises and the regulatory authorities,is entirely understandable.

But I would just like to point out the fact that the balance of payments plays an essential role in a nation's economy,including ours. It is one of the four key areas of our macroeconomic control. We conduct a dynamic form of regulation that responds to a dynamic state in the balance of payments.

When the balance of payments shows a big surplus,our priority is to prevent inflows of hot money. In the same way,when the US raises interest rates and the Chinese economy experiences a soft landing,our priority is to prevent capital flight.

Regulatory measures can be adjusted according to actual circumstances and development trends. This is fair and reasonable. By adjustment,I did not mean frequent changes of policy measures but rather changes needed to maintain regulatory principles and patterns as well as the same goal in investment,financing and trade facilitation. It is necessary to adapt to these dynamic regulatory measures.

Q: Keeping pace with these dynamic regulatory measures can be a difficult task. What changes will you make to cope with the developments in the balance of payments?

A: Economists always talk about the balance between supply and demand. We regulators discuss the equilibrium of income and expenses in the context of the balance of payments. In terms of cross-border capital flows,our management of foreign exchange is designed to prevent massive inflows or outflows,or rapid and disruptive movements. In exchanges of local and foreign currency,short term speculative hedging is definitely not encouraged,but centralized purchases and sales of local currency in large quantities are two possibilities. These two options must adhere to the principle of reflecting real demand and having authenticity. By "demand" I am referring to reasonable operating demands and by "authenticity" I mean there must be an authentic underlying trade.

Q: Is it permissible for enterprises to conduct asset allocation between domestic and foreign currencies? Can companies integrate onshore and offshore assets? What kinds of activities would violate SAFE rules?

A: Those are two very tough questions. They touch on issues encountered in regulatory practice every day. Asset allocations can be seen as reasonable activities when they are conducted according to the principle of whether there is real demand and whether there is a legitimate underlying transaction. What matters most in this kind of situation is whether the desires of a market participant meet reality. Different market participants may hold different views of the market. They may also want to hedge their positions and thereby achieve the desired asset allocation. But when the market is one-sided and when its only consideration is the level of foreign exchange reserves,rationality and the overall factual conditions can be overlooked. The net stock of foreign exchange is a state's foreign exchange reserves. One could imagine what would happen after this kind of hedging. I do not think any of the players in the Chinese market want to see that happen.

Capital inflows and outflows are affected by the degree of openness in the economy. Under the current regulatory framework,capital management treats onshore and offshore capital pools separately. The two capital pools can be connected to a certain extent but in a properly regulated manner.

Q: Could you give us some insight as to how the foreign exchange reserves are actually managed? What are the objectives in their use?

A: I'm afraid I'm not the right person to answer your first question. Foreign exchange reserves are managed by a professional team. But foreign exchange reserves,as the assets of the People's Bank of China,are regarded as a "reservoir". There are basically three features to the use of these assets. First,foreign exchange reserves must be sufficient to ensure China can make its daily import payments. This is a basic requirement for the economy to function properly. Second,the nation must be able to make payments in full on its maturing foreign debt. This is a matter of reputation.

And let me offer a little reminder to enterprises. When borrowing abroad,they need to take into full consideration the capacity to obtain foreign exchange and not just exchange rate fluctuations and interest costs. The internationalization of the renminbi is a work in progress. It will take some time for the renminbi to become an asset that is recognized by all international creditors. Lastly,reserves are needed to ensure the legitimate after-tax income of foreign investors. An official from SAFE stated during the "two sessions" - or the annual meeting in March of the legislature and its advisory body - that China' policy on the utilization of foreign capital will not change. The lawful rights and interests of foreign investors remain assured. Once taxes have been paid,profits of foreign investors can be transferred abroad or reinvested in China.

Q: Has China already begun restricting the development of ODI? Market participants seem to think so.

A: The scale and pace of overseas direct investment has not been tightened or slowed,but our priority in the current stage is to ensure effective investment. Firstly,ODI should be generally in line with the development strategy of the "One Belt,One Road" initiative,and there should be a systematic interaction. Moreover,relevant departments need to make sure that proper attention has been given to the feasibility of offshore projects and that environmental risks are considered. More importantly,relevant departments must ensure that investments projects are not just a means of transferring assets offshore.

Some projects are investments in overseas real estate,but in these cases the buyers are usually domestic individuals. This is compatible with our regulations.

Q: It appears that the net level of foreign exchange reserves is related to capital controls. Is it also linked to volatility in the exchange rate? Some economist say we should protect the level of foreign exchange reserves and relax the exchange rate.

Q: The exchange rate is the price paid when exchanging currencies and this price is definitely linked to the volume of foreign exchange reserves. In this case "positive correlation" and "negative correlation" are not the only matters we need to consider. What really matters here is to what extent they are related to each other and how sensitive that relationship is. Market participants,scholars and regulatory supervisors all have their own perspective when analyzing market conditions. We should keep in mind,however,that sometimes volume influences expectations and at other times price is the determining factor. China's economy is making progress in its development while maintaining overall stability. At the moment,stability is the key word.

Q: How do the foreign exchange reserves relate to renminbi internationalization? Some people may say that China has slowed its efforts to internationalize the renminbi. What is your view?

A: I've already touched on the issue of "correlation" and "sensitivity." The internationalization of the renminbi is a natural progression. Sometimes it moves ahead at a fast pace and sometimes the movement is slower. The market is the driving force in this process. The renminbi has been included in the International Monetary Fund's Special Drawing Rights basket with a 10.92% weighting. Many central banks have signed currency swap agreements with China. Offshore renminbi markets have been established. All of this indicates that the internationalization of the currency has made significant progress whether we view it from the perspective of international trade settlements or as a means of investment,financing or as a foreign exchange reserve asset. I think the internationalization of the renminbi is a long journey that will be determined by the market,rather than other factors.

Q: We touched on this earlier but can you elaborate on the relationships among foreign currency reserves,capital controls,exchange rate fluctuations and domestic currency internationalization? And how should this relationship be viewed in a rapidly developing economy like China's?

A: Foreign exchange reserves must be maintained at a certain level in order to guide market expectations when the exchange rate fluctuates abnormally. A reasonable volume does not mean an extremely high level or a low one. The exchange rate has always been seen as a key indicator of market supply and demand. It exerts influence on the size of the foreign exchange reserves.

Renminbi internationalization will be promoted in an orderly manner based on the extent of our foreign exchange reserves,the degree of marketization in the exchange rate formation mechanism and effective capital account administration.