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Capital Markets, Financial

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Categorized | Currencies

Beijing battles to close capital flight loopholes

Posted on November 29, 2016

Getting money out of China has always been a challenge, so much so that some enterprising individuals have experimented with smuggling fossils to sell on the international black market for cash.

Most people have discovered that financial transactions involve less heavy lifting, although they are not always simpler. The long list of roundabout ways to move money out of China keeps evolving, as regulators constantly find and close loopholes.

But a move by four agencies this week to regulate overseas mergers could put a stop to a favoured channel for moving vast sums out of the country. A series of eye-catching overseas purchases by Chinese companies this year has raised suspicions of capital flight, and helped weaken the currency.

“The reason is to allow the market in the future to reflect real economic activity and not underground or grey transactions,” said Zhao Xijun, deputy director of the Finance and Securities Institute at Renmin University.

Chinese overseas direct investment has soared for legitimate reasons: excess industrial capacity constructed in China over the past decade means that margins are thin, and well-run businesses in Europe or the US with stable albeit low returns are seen as a valuable hedge. China’s sudden emergence as the world’s largest oil importer, biggest consumer of most other commodities and producer of half the world’s steel or aluminium has required securing mines, oilfields and infrastructure abroad. 

But large transactions that defy logic and complicated payment structures that include layers of consultancy fees are often an indication that fleeing capital has bundled itself into the deal. 

Meanwhile individuals and smaller companies have had to be content with more creative means of egress. China is only slowly opening legal channels for legitimate profits to be moved across its borders, meaning its capital controls awkwardly conflict with its status as the world’s largest trading nation. Since the 1980s, those who had the connections to operate shell companies abroad have made a profitable living settling trade invoices and meeting other business needs.

When the Chinese economy is booming, moving money in becomes as difficult as moving it out during slumps. A craze for over-invoicing imports from Hong Kong has replaced the rampant over-invoicing of exports that peaked in 2013.

The most recent hole to be plugged was the practice of buying millions of yuan in insurance policies in Hong Kong, an option that Mr Zhao of Renmin University calls “investment under the cover of trade in services.” That channel was abruptly shut this month by China Unionpay, the state-backed bank card monopoly. “If you buy a few yuan worth of insurance to go travelling that’s one thing. But millions of yuan in insurance when you yourself are not even in Hong Kong? That’s an investment,” he explained. 

That follows a crackdown on junket trips to gambling haven Macau, long a favourite method of moving out money acquired corruptly. Gamblers could deposit money in the mainland then cash out their chips in Macau — or, in a more complex variation, invest their winnings in manipulated boiler-room stocks in Hong Kong.

Other popular channels have included the online currency bitcoin, which can be purchased in China and sold for another currency in a foreign country. And some jewellery stores allow expensive pieces or gold to be purchased in the mainland and sold back in Hong Kong — or vice versa, for those who need to move money in.