Forex Situation at Crossroads

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On December 27, 2011, the State Administration of Foreign Exchange (SAFE) published the data, showing that the proportion of short-term foreign loans in the total balance of foreign loans has hit the historical high of 72%.

Though the SAFE stated that the change of short-term loans suits the growth of China’s imports and exports trade. Some analysts said that this new height of short-term loans is unusual and is closely related with the inflow of hot money. Simultaneously, the foreign exchange settlement and sale by banks saw a deficit in November 2011, showing that the hot money was flowing out of China.

In spite of that, the SAFE did not want to loosen the strict control over the capital inflow. But the strict regulation harmed the foreign-funded companies which have real need of foreign currencies.

New Record of Short-term Foreign Loans

The SAFE’s data shows that the balance of short-term loans of China reached 507.625 billion U.S. dollars by the end of September 2011, taking 72.81% of the balance of foreign loans, higher than 71.92% at the end of 2011. In truth, the proportion of short-term foreign loans in the total amount of foreign loans kept increasing in recent years. Data show that the proportion of short-term foreign loans in the total amount of foreign loans was 57.39% in the first three quarters of 2009. By the end of 2010, the proportion had increased to 68.44%. In the following three quarters, the proportion never dropped back below 70% again.

The balance of trade-related credit reached 374.996 billion U.S. dollars, taking 73.87% of the short-term loans’ balance. The inter-enterprise trade credit took 50.55% and the banking trade financing took 23.32%. The SAFE announced that the trade-related credit has a true setting of imports and exports trade and its growth is on speaking terms with the growth of China’s imports and exports trade.

But the experts think that the continuous increase of short-term loans is related with the inflow of arbitrage capital. Zhou Wenyuan, research director of Guotai Jun’an Securities, said that the appreciation of RMB and the interest spread between domestic and foreign markets attract companies to realize arbitrage through holding foreign loans. It is believed that the short-term loans can function better than long-term loans in avoiding market risk, which leads to the continuous increase of the proportion of short-term loans.

The research report from the Bank of China said that the growth of short-term foreign loans is also closely related with the anticipation for RMB exchange rate. From 1998 when the RMB had the stress of depreciation, the growth rate of short-term foreign loans had an obvious decrease till 2000. When the RMB appreciation stress arose in 2002, the growth rate increased in 2003. The proportion of short-term foreign loans has a fast increase from 2004 to the first half of 2006 and then it was eased for a while till the return of acceleration in the first quarter of 2008.

Li Chao, deputy director of the SAFE, admitted that the high proportion of shortterm foreign loans was due to the fast increase of net export trade volume. In addition , the interest spread between the RMB appreciation anticipation and the domestic currencies. He thought that the risk of short-term loans is controllable, but the proportion has exceeded the international alert level and needs “special care”, including proper control and management.

Damage the Innocent Bystanders

“We are completely different from the hot money. But every time the SAFE enhanced the regulation, we will suffer as well,” said Lin Zhijie, board chairman of a Hunan-based for- eign-funded company. Though the company went through “enhanced regulation” but never became “as immobile as in 2011”.

In the middle of 2011, Lin Zhijie’s company raised 20 million U.S. dollars from the overseas and planned to transmit it into China through additional investment of shareholders. Lin Zhijie wanted to use this amount of capital to add a new production line. However, after the capital was transmitted to a domestic bank in August, 2011, Lin Zhijie’s company had no right to use it.

“The banks asked us to issue the original copy of the invoice,” said Lin Zhijie. However, after they handed the invoice, the bank refused to settle the foreign exchange by stating that the authenticity of the invoice cannot be confirmed. “Our suppliers urged us to pay for their goods, but we could make it despite the 20 million U.S. dollars in our bank account.”

This is because of the new measures taken by the SAFE as of August 1, 2011. The new measure, whose name is “The Supplementary Notice from the SAFE about Completing the Foreign Exchange Settlement Management for Foreign-funded Companies” or the “No. 88 File”, required the foreign-funded companies to submit the original copy of invoice and ensure the authenticity of the invoice when dealing with the foreign exchange settlement.

The original copy of the invoice should be put under the file of the official website of local taxation department before being given to the banks and the banks can confirm the authenticity of the invoice online. But some places’ taxation departments have no websites and thus the banks require the taxation department to submit “written materials that are given by taxation and can prove the authenticity of the invoice”.

“But when we ask the taxation department to issue these materials, they said this was beyond their responsibility and refused to issue the materials.” Without the written materials, Lin Zhijie could not finish the foreign exchange settlement. Without the capital support, his company’s production was severely hindered.

Apart from authenticating the materials, the “No. 88 File” put out higher requirements for the banks, including the principal requirements for the banks’ prudence obligation –the banks are required to attach importance to the compliance, authenticity and uniformity of the materials.

The stricter regulation about foreign exchange settlement has its own reasons. When the RMB keeps appreciating, the foreign exchange principals of enterprises are seeing decreasing value. There are some enterprise making use of false contracts and invoices to conduct the foreign exchange settlement. That’s why the SAFE requires the authenticity of the invoice.

“It is right to take these measures, but they should cooperate with the taxation department,” said Lin Zhijie with complaints.

At the Crossroads

On December 28, 2011, the SAFE published that the foreign exchange settlement and sale by banks had a deficit of 800 million U.S. dollars in November 2011, the first time from 2010. Another group of data shows that the foreign exchange settlement and sale by banks in the first 11 months of 2010 had the surplus of 382.1 billion U.S. dollars.

“This is a kind of balance,” said Tian Tianyi, a foreign exchange analyst from Yayin International Co., Ltd. From the end of September 2011, the number of speculative deals of RMB exchange sellout had a sudden increase. According to Tian Tianyi, this does not mean that the hot money is flowing out of China.

In the late period of November 2011, the RMB had shown the trend of depreciation. Deng Xianhong, deputy director of the SAFE, said that the complicated domestic and international economic situation forced the SAFE to continue the strict control of the flow of hot money. The primary task is to enhance the supervision of the abnormal cash inflow of enterprises and banks.