China, Fighting Money Exodus, makes life tougher for companies and investors

By Wei Gu and Chuin-Wei Yap

Chinese officials are trying anew to slow a money exodus from the country, clamping down on individuals seeking to flee the yuan and making life tougher for companies that need to trade the currency for dollars to do business.

China’s foreign-exchange regulator in recent months has deployed a new system to monitor individual purchases of foreign funds and has asked banks to reduce foreign-currency transactions. It has summoned bankers to its offices to give guidance and has grilled them when foreign-exchange activity spikes, according to executives at Chinese and foreign lenders.

Banks, in turn, have increased scrutiny of foreign-currency transactions by businesses ranging from Chinese entrepreneurs investing abroad to companies paying overseas bills.

A European chemicals manufacturer recently faced delays in Shanghai in obtaining U.S. dollars, threatening its deadline for an overseas licensing payment. The Bank of Tianjin is having trouble getting funds from mainland investors for a planned Hong Kong public stock offering. A water-treatment company struggled to withdraw $2,000 for an engineer to travel to the U.S.

“There appears to be a real crackdown on money flowing out of China,” said Jean Francois Harvey, global managing partner at Hong Kong law firm Harvey Law Corp., whose clients have had difficulty recently transferring money out of China for equipment purchases and investment. “Even normal business transactions which are ongoing are getting delayed.”

Mr. Harvey said a Chinese client is having problems wiring $15 million to a Hong Kong company that for two years has been helping it buy equipment for a South American factory. “There’s no indication that the money will go through,” he said, “and we heard from our client that it was due to restrictions on money transfer.”

The clampdown comes atop Beijing’s steps after last summer to stem outflows, from restricting cross-border yuan business at foreign banks to cracking down on individuals who are flouting the country’s strict foreign-currency quotas.

Economists say tightened capital controls are one reason China’s foreign reserves fell only $28.6 billion in February, less than a third the drops of the two previous months.

Spooked by slowing growth and a declining currency, Chinese businesses and consumers are trying to move money abroad where its value might hold up. Last year, some $700 billion to $1 trillion is estimated to have fled China.

That is more than the economy of Switzerland and equivalent to as much as 10% of China’s massive GDP. China’s foreign-currency reserves fell by a record $107.9 billion in December from November and another $128 billion in January and February combined, putting reserves 20% lower than their June 2014 peak.

The outflows destabilize the currency and make China’s decelerating economy harder to guide. The government is already wary about loosening monetary policy to stimulate growth, as that could weaken the yuan further and send more money abroad.

Chinese regulators have said they aren’t too concerned about the outflows and that they aren’t imposing new or additional capital controls. Central bank Vice Governor Yi Gang over the weekend told reporters China’s recent foreign-reserve declines are “within our expectations.” The central bank didn’t respond to inquiries on outflows; its foreign-exchange arm said it hadn’t introduced new capital controls.

Much money has left through legitimate channels, which are broader after years of gradual currency liberalization that makes it harder for authorities to tamp down. China lets each individual buy up to $50,000 of foreign currency a year, for example.

ENLARGE

Jun Wan, a Shanghai insurance-company executive, said he was concerned by the weakening yuan and wanted to move some savings abroad before it slipped further. In December, he used his quota, his wife’s and his 7-year-old daughter’s to buy a $120,000 U.S.-dollar insurance policy in Hong Kong. “People don’t have faith,” he said, “in what China will become in 10 years.”

If 5% of China’s roughly 1.4 billion people used their full quotas, the $3.5 trillion in foreign-currency demand would drain its reserves.

Some have found creative ways to get around those quotas.Shanghai-based collector Liu Yiqian said that late last year he bought an oil portrait of a nude woman by Italian artist Amedeo Modigliani for $170 million. He used his American Express Centurion card to pay for the painting. Many card purchases are exempt from China’s foreign-currency caps.

Of $550 billion in China’s net capital outflows in the 2015 second half, about 60% was from Chinese residents and companies buying foreign currency for everything from travel to acquisitions, while another 30% was from Chinese companies repaying dollar debt,Goldman Sachs estimated in a January report.

Beijing property developer Soho China Ltd. decided to pay down some of its dollar-denominated debt after the yuan started weakening sharply. Late last year, it bought back some of its $400 million offshore bonds due 2022 in a tender offer and redeemed $600 million in 2017 notes. Earlier this year, it issued new yuan debt onshore at a much lower rate to replenish its funds.

Soho CEO Zhang Xin told The Wall Street Journal that the company decided to repay foreign-currency debt because “all of our revenue is denominated in yuan, so a falling yuan would have been a big foreign-exchange risk for us.” Ms. Zhang said Soho’s foreign-currency-denominated debt now accounts for just 16% of its total debt, so “we don’t have to worry about the foreign-exchange risk anymore.”

Chinese firms’ net repayment of foreign-currency debts inside and outside China amounted to $41 billion in the third quarter, which partly explains the rapid fall of reserves, according to Bank for International Settlements.

Chinese companies are also sending more money overseas through investments, making $85.8 billion in outbound acquisitions announced through March 7, according to Dealogic, almost eight times the value in the year-earlier period.

Some experts, such as Tao Wang, China economist for UBS, agree with the government that the outflows aren’t alarming. The country continues to earn dollars from exports, logging a record trade surplus in 2015. China had $3.2 trillion in foreign reserves at the end of February, more than twice Japan’s holdings.

ENLARGEA bank employee checks banknotes in Lianyungang, China, in January. Concerns about a weakening yuan have prompted some investors to seek safety abroad. PHOTO: XINHUA NEWS AGENCY/GETTY IMAGES

Some economists calculate the country could get by with $2 trillion in reserves or less, especially if it strengthens capital controls. Others estimate China needs a reserve cushion of at least $2.6 trillion to $3 trillion, given the size of its money supply and foreign debt. At the rate China’s foreign reserves were dropping at last year’s end, they could dip below those levels in less than a year.

Chinese regulators began tightening their grip on outflows after last summer’s market turmoil and increasing signs of a growth slowdown. China’s foreign-exchange regulator, the State Administration of Foreign Exchange, or SAFE, in September putlimits on the amount of money Chinese bank-card holders could withdraw from ATMs abroad.

In January, it rolled out a new system to monitor individual purchases of foreign currency. Credit-card companies in February began to make it harder to charge the purchase of overseas insurance policies.

SAFE said in an email to The Wall Street Journal that it hasn’t introduced new capital controls, and that the “effectiveness of capital controls is limited, and not suited for the country’s strategic direction.” The regulator also said its inspections found some banks weren’t complying with requirements to show legal foreign-exchange receipts, and some were even advising customers on how to flout the law, so it will continue to “strictly supervise” banks’ implementation of foreign-exchange rules.

Then there is the stealth clampdown. SAFE officials have told banks to reduce foreign-currency transactions, starting with large state-owned and foreign lenders at the end of 2015 and moving on to midsize lenders this year, according to several bank executives who got the orders, which weren’t released officially.

“Those were all verbal requests,” said an official at a Chinese bank. “No paper trail has been left.”

The regulators asked lenders to stop advertising foreign-currency deposits and services, the bank executives said. One banker said SAFE officials called regularly to ask why the bank was buying so much foreign currency for their clients and sometimes brought bankers to SAFE’s local branches to give them instructions.

SAFE officials asked whether the bankers had checked the purpose and authenticity of the transactions, requesting that they “take measures to control” the amount of foreign currency they bought, the bank executives said.

To comply, many banks have come up with stalling tactics, from asking customers to produce written statements about the purpose of their transactions to delays of up to a week in giving out cash, they said.

The Bank of Tianjin, which hopes to raise up to $1 billion from an initial public offering in Hong Kong this month, is having trouble securing funds from large mainland investors, said people familiar with Tianjin. Some channels those investors had typically used to send money overseas are drying up, said bankers. The lender declined to comment.

In January, the chief financial officer of a big European chemicals manufacturer in Shanghai noticed that obtaining U.S. dollars for an overseas payment was taking much longer than usual. China’s capital-control rules require companies to get approval before exchanging yuan for foreign currencies.

The company was trying to procure $610,000 to pay an annual technology-licensing fee, which normally took 20 days. China’s foreign-exchange regulator kept asking for more documentation on matters such as the purpose of the funds to details on the products and technology involved, dragging the approval process far beyond that and making her anxious the company wouldn’t meet its payment deadline.

Earlier this year, a Fujian-based water-treatment company wanted to withdraw $2,000 travel expenses for an engineer being sent to the U.S. to install equipment for a client. In the past, that could be done with one day’s notice at the Bank of China, said the company’s chief financial officer. This time, it took a week.

Government officials have maintained they are simply asking banks and financial institutions to apply the letter of the law to cross-border transactions.