China Tightens Control on Foreign Currency, Betrays Private Firms
A Chinese political economist who fled to the U.S. in exile revealed the harsh reality of China’s foreign exchange reserves that are available for import payments and external debt repayments.
Political economist
Dr. Cheng Xiaonong
Cheng was born in Shanghai in 1952. He holds a master’s degree in economics from Renmin University. After working as the Deputy Director of the Research Institute of China Economic System Reform, established by former Prime Minister Zhao Ziyang, he studied abroad in Germany and France from 1988 to 1991. He earned a doctorate in sociology from Princeton University. Cheng has fled to the U.S. in exile. He served as the chief editor of the academic journal, “Modern China Studies (当代中国研究).
Authorities in China announced their foreign exchange reserves to be $3.218 trillion at the end of October 2021. In order to get a real picture of a country’s financial assets and solvency, however, we must subtract total liabilities and take a look at net foreign exchange reserves.
Less Than One-Sixth of Forex Reserves Available For Use
China’s foreign bonds in June 2021 were $2.6798 trillion, which gives us net foreign exchange reserves of $534.2 billion. Compared to 2014 when net reserves were $2.0631 trillion, it has fallen by $1.5289 trillion, a 75% decline.
The decrease in China’s trade surplus is only a secondary cause of the decline in net reserves. In fact, the main reason is that the total amount of foreign bonds that must be repaid by the Chinese government and companies has rapidly increased to about $1 trillion over the past seven years.
On the surface, total foreign exchange reserves are maintained at a sufficient level. But there is an increasing risk that foreign currency required for external debt redemption and daily imports and services will cannibalize and eat into the other.
Private Currency Can’t Be Withdrawn Freely
Due to these circumstances, the Chinese government is tightening control on foreign currency. Neither mainland companies nor foreign companies investing in China can exchange transactions in foreign currency. Both private companies and residents in China are forced to turn in all foreign currency to Chinese banks in exchange for the renminbi (RMB). Furthermore, the foreign currency of the private sector, collected by China’s central bank through its financial system, is included in the country’s total foreign exchange reserves that the government announces.
Withdrawals of foreign currency are restricted in various ways. If your child is studying abroad and you want to exchange money to pay tuition in foreign currency, the bank may ask you to disclose your child’s grades. Additionally, you can only exchange up to $50,000 annually.
If a company tries to withdraw foreign currency at a bank, the banker will often make excuses that they need to get approval from the higher-ups and indirectly reject them. Taiwanese businessmen are also finding it difficult to bring home profits from China back to Taiwan in the form of foreign currency.
China Has No Allowance to Pay Back Foreign Debt
Compared to the amount of foreign bonds at the end of December 2014, the amount of foreign bonds in the government sector, specifically long-term debt, has increased sharply by June 2021. Foreign bond balances of commercial banks and non-financial companies are increasing too. Short-term debt makes up about 70% of private sector bonds.
I won’t go into details, but what we can see from this is that Chinese banks and non-financial companies could default on the estimated $1.5 trillion in short-term foreign bonds in the near future.
Right now, Chinese companies are issuing new bonds to redeem their old debt, so there shouldn’t be any imminent worries of a decline in net foreign exchange reserves.
But if exports decrease to some extent, the surplus balance of payments will be insufficient to stabilize total foreign exchange reserves. In light of the average monthly spending from the current account, current net foreign exchange reserves will only last three-and-a-half months of the required amount.
In other words, if you give priority to foreign currency required for daily imports and services, there is a risk that they will not be able to obtain foreign currency required for external debt redemption.
China’s Government Won’t Help Private Companies
Of the many factors that make up China’s foreign exchange reserve risk, there are two main factors.
One is that foreign companies in China may withdraw funds on a large scale. When that happens, the Chinese government may spend their limited foreign exchange reserves or otherwise refuse foreign currency payment.
The second factor is for the outward credit scores of Chinese companies to decline, making it difficult to issue new bonds abroad. In that case, China may try to meet the demands of foreign currency for redemption purposes in order to bail out Chinese companies. There is the possibility that China will run out of its net foreign exchange reserves.
If there is no allowance for net foreign exchange reserves in these dangerous situations, the Chinese government will give top priority to pay off imports and services with foreign currency. Next, they will use foreign currency to support outward credits of domestic banks. They will also try to limit foreign companies from pulling out of the Chinese market and withdrawing foreign currencies. The government will generally abstain from providing private companies the foreign currency needed to redeem foreign bonds, leaving these companies to go bankrupt.
The reason why the Evergrande Group can’t redeem foreign bonds is not because it lacks RMB funds, but because the government does not provide foreign currency.
