China's 'Tobin Tax' debate stings City hopes for offshore trading boomBy Ambrose Evans-Pritchard
5:15PM GMT 05 Jan 2014
http://www.telegraph.co.uk/finance/comment/10552041/Chinas-Tobin-Tax-debate-stings-City-hopes-for-offshore-trading-boom.htmlBritain’s bid to become a global hub for trading in Chinese assets has run into a major snag after a top Chinese official suggested a ‘Tobin Tax’, a levy on financial transactions to curb capital flows.
Yi Gang, director of the State Administration of Foreign Exchange, called for an “in-depth study” of a Tobin tax, particularly on foreign exchange trades and flows of speculative hot money. SAFE is the world’s biggest fund, commanding the central bank’s $3.7 trillion in foreign reserves.
Any such move could greatly complicate the City of London’s plans to become the top market for global trading of the yuan or renminbi, since the clear intention would be to reduce turnover and limit disruptive flows of capital.
Mr Li, who is also deputy chief of China’s central bank, wrote in the Communist Party journal Qiushi that curbs may be needed to ensure an “orderly” transition as the country opens up its internal capital markets and moves towards a free float for the yuan.
“Persistently guarding against cross-border liquidity flow shocks is the key to good foreign exchange management,” he wrote. While the article is not a formal proposal, his opinions are closely-monitored as a guide to future policy.
The US-educated Mr Yi said last month that China should stop accumulating huge reserves, arguing that the exchange rate is near “equilibrium level”. He wants the yuan to be set by supply and demand, but this must be managed with great care.
George Osborne, the Chancellor,
secured a deal in October that would make London the first overseas centre allowed to invest directly in Chinese stocks, bonds, and funds, with an initial cap of £8bn. Chinese banks will set up branches in Britain. Mr Osborne called it “a huge boon for British financial services, for Britain as a centre of global finance”.
But China experts said any Tobin Tax would be a cold douche. “It would reduce investor interest in London as an offshore yuan market, though it is positive for Chinese economic prospects. They have realised that they cannot open the capital account without controlling capital flows,” said one economist.
Yi Gang told Caixin Magazine that “some people are preparing for a hit from events more disastrous than the Asian financial crisis in 1997 and the collapse of Lehman Brothers in 2008”, apparently referring to those in Party circles resisting reform. He insisted that SAFE’s war chest is already big enough to tackle “any scenario”.
East Asia has been bedevilled by speculative flows over the last twenty years. The concern is that money will pour into China amid euphoria over reform plans, increasing the risk of an exodus later if the mood turns.
Mr Yi said SAFE has a “response mechanism” for dealing with speculative inflows that cross a danger threshold. It has been activated three times since 2010.
The Tobin Tax is named after Nobel laureate James Tobin, the scourge of unbridled capital flows. France and Italy have pioneered variants in Europe to raise revenue and punish speculators but this has driven business elsewhere.
The French levy raised a third of the tax expected. Eleven eurozone states plan to press ahead together in 2014, but Britain will not take part. Prime Minister David Cameron called it “sheer madness”. The US, Switzerland, Singapore, and other financial hubs will have nothing to do with it.
However, it is a different calculation for China as it seeks to open up a closed system one step at a time. Vast flows of capital are making it harder for the central bank to calibrate policy as it tries to cool the credit boom. Investors are betting on a further appreciation of the yuan though this is a risky game.
Diana Choyleva from Lombard Street Research said double-digit wage rises over the last decade have greatly eroded China’s competitiveness. arguing that the yuan may be 30pc overvalued - contrary to widespread assumptions.
The country’s financial shake-up under Xi Jinping could lead to large outflows. Mrs Choyleva said China’s annual savings of $4.2 trillion - more than savings of the US and Japan combined - create a “huge wall of money” to be unleashed on the world.
“If the Chinese are offered the opportunity to diversify their assets abroad in a legal manner rather than trying to evade capital controls, capital outflows are likely to be much larger than before.”
“Meanwhile, foreigners’ current enthusiasm about China is based on the false perception that reform means immediate opportunity and continued strong growth. The adjustment over the next couple of years is more likely to be accompanied by weak growth, corporate defaults, financial instability and potential social unrest,” she said.
Wealthy Chinese are already smuggling money out by over-invoicing imports or through Macao - for 20pc fee. This is overwhelmed for now by hot money inflows.
President Xi unveiled sweeping market reforms at Third Plenum in November in a bid to avert a classic ‘middle income trap’ as the country’s catch-up growth model nears exhaustion.
But he has tightened the Party’s control over the political system and Chinese society at the same time. Critics say this is an inherent contradiction. One or the other has to give.
