Will it or won't it? If by the time this article appears you know the answer, it will be because China has done what numerous officials have so far pledged not to do devalue the yuan.
Of course, China is not as exposed to market forces as many other Asian countries, since the yuan is not freely convertible on capital account. The People's Bank of China (PBOC), which is responsible for the overall management of China's foreign exchange and gold reserves, sets the official exchange rate for the yuan against foreign currencies. While China has taken indirect steps to help its exporters whose goods have become relatively more expensive, for example by raising export tax rebates for some products and machinery, the headline exchange rate figure has been more or less preserved. However, in September the foreign exchange black market rate reached as high as Yn9.20 to the US dollar compared with. an official rate of about Yn8.20.
Forex loan hedging
This has not prevented companies operating in China from seeking to minimise their exposure, should devaluation occur. A common method, particularly for those whose business is largely domestic and therefore in yuan, but which have mismatching foreign currency borrowings, has been to try to convert those borrowings into local currency. This is done by prepaying existing loans and borrowing in yuan instead.
The PBOC recently moved against this activity through the State Administration of Foreign Exchange (SAFE), its subordinate body. It is SAFE which handles approvals and registrations relating to exchange control and which monitors foreign exchange bank accounts, so as to ensure that the right receipt or payment is made in the right kind of account.
The PBOC issued an internal circular in August 1998, entitled Regulations on the Verification of Authenticity of Foreign Exchange Payments for Import, which was only released to foreign banks in September. The circular forbids the' use of yuan loans for any purpose other than production, and explicitly forbids the use of loans to purchase foreign exchange for loan repayment. Banks may not provide loans to Chinese institutions inside China which are guaranteed by foreign financial institutions.
The circular strengthens SAFE supervision over foreign debt registration. It instructs SAFE to inspect foreign loan agreements carefully, and gives SAFE the power to refuse to register loans under certain circumstances: if the registered capital of the borrowing foreign investment enterprise is not fully paid up; if the loan amount exceeds the amount approved by approval authorities; or if the interest rate is higher than the prevailing rate in international financial markets. Legal opinions must be submitted for loans of less than six months.
The circular also addresses SAFE's super-vision of the repayment of foreign exchange loans' principal and interest. Repayments must be made in strict accordance with the provisions of the loan contract. Prepayments may only be made if the contract specifically provides for them, and even then only from the borrower's own foreign exchange funds, if possible. SAFE will investigate any purchase of foreign exchange for repayment of US $1m or more.
Controlling capital accounts
Another government circular aimed at controlling the supply of yuan, the Circular Regarding Questions on Improving the Management of the Settlement of Foreign Exchange for Capital Account Purposes, was issued by the State Development and Planning Commission, State Economic and Trade Commission and the PBOC a little earlier, in May this year. This circular emphasises the need to use yuan funding for China projects, whether domestic or foreign invested, and to decrease dependence on foreign capital.
This circular requires the feasibility study of foreign invested projects to include an annual plan for the settlement of foreign exchange funds for capital account items. The approval authority for the project must check and ratify the settlement quota when examining the feasibility study report, and submit this information to SAFE. In order for a foreign invested project to make settlements, it must file a settlement report; settlement amounts larger than the quota from the feasibility study report must be reported to central SAFE. Officials have said that this quota should apply to loans which are used for capital account purposes, but not to cur-rent account items such as interest and dividend payments.
Approvals for issuing B-shares, which use foreign exchange, or for issuing shares out-side China are limited by the circular to listed companies with a ?direct need' for foreign exchange. Listed companies must also include settlement information in their prospectuses. Foreign exchange income must be kept in Chinese banks in Hong Kong, and foreign exchange to be used in China may be brought into China in instalments to be settled.
The purpose of these provisions is to decrease foreign exchange obligations and to supervise their use. The circular expressly warns against interest arbitrage through the settlement of commercial loans from foreign sources.
Foreign exchange crackdown
This summer, SAFE also issued a series of rules and circulars toughening the management of foreign exchange flows from trade. The Implementing Rules for the Administration of the Write-off of Foreign Exchange Income for Exports impose strict reporting and verification procedures for foreign exchange income from exports. The implementing rules and the Circular on the Promulgation of Regulations on the Verification of Authenticity of Foreign Exchange Payments for Import impose similar procedures.
Their aim is to ensure that there is no unauthorised buying and selling of foreign exchange under the guise of trade. Among other things, they strictly prohibit the unauthorised use of verification certificates for collection of foreign exchange for exports, impose complex measures for verifying that goods are actually traded, and re-state the requirement for surrendering foreign exchange earnings. The Circular on Relevant Issues to Strike Against Illegal Exchange Arbitrage Activities, issued in July 1998, exhorts SAFE offices to crack down on such illegal exchange activities.
Freshfields is an international law firm. Most of its offices throughout Asia, Europe and North America include China specialists. For further details, contact Matthew Cosans through its Hong Kong office, tel: (852) 2846 3400 or its Beijing office, tel: (86) 10 6410 6338 or by e-mail (email@example.com).
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