China's Forex Rules Begin to Loosen Capital Controls

a) Permission for some Chinese domestic companies to open forex bank accounts and keep forex income.

The present Chinese forex control system was established in 1994, under which the biggest changes included, among others, those forbidding most domestic enterprises and entities other than import/export companies from opening and maintain forex accounts, introducing the forex settlement and purchase system (外汇结售汇制度) (under which all domestic enterprises and entities without forex accounts should sell their forex revenues to the state via banks licensed to conduct forex transactions, and when forex payments are to be made, they need to purchase forex funds from the banks and in most cases such a purchase requires the advance approval or verification of SAFE),¹ and establishing the Chinese Foreign Exchange Transaction Centre (中国国家外汇交易中心) in Shanghai as the interbank market.

Pursuant to the November 12th SAFE notice quoted above, those domestic enterprises with import/export authority are permitted to open forex settlement accounts if their annual forex income exceeds the equivalent of US$2 million and their annual forex expenditure is more than the equivalent of US$200,000.² The enterprises can keep their forex funds in that account with a cap of 25% of the previous year's export-generated forex income or of its previous year's forex expenditure, whichever is lower.

b) More freedom for Chinese citizen's demand for forex funds to use when in pursuit of university or other higher degrees undertaken overseas. People are allowed to purchase forex funds from local banks to cover their overseas tuition and living expenses, with the maximum amount increased from US$2,000 to $20,000, and for purchase transactions lower than the cap, they no longer need SAFE's advance approval.

c) The authorities have made some changes to the administration of forex loans extended by domestic banks and other financial institutions (国内外汇贷款, Òdomestic forex loansÓ) and have eliminated some approval requirements in 11 experimental provinces and cities. Borrowers are not required to register loans each time a loan agreement is signed, and the burden is shifted to the lenders; the latter will make the registration at the local SAFE branches on a periodic basis, presumably once every month. In addition, the original ban on the borrowers' purchase of forex funds to repay overdue loans has been abolished, and for repayment in which borrowers used their own forex revenues as per the schedules stipulated in the loan agreements, the banks of the borrowers are authorized by SAFE to verify the applications, and no advance approval of SAFE is required.

d) The authorities have eased restrictions on repayment of domestic forex loans, loans extended by foreign lenders (外债 "foreign loans") and trans-foreign loans (外债转贷款) that were introduced in 1998. These restrictions were imposed at that time as a measure to minimize the harm to Chinese forex reserves by the Asian financial crisis. According to the prior restrictions, without a pre-payment clause in the loan agreement, the Chinese borrowers were not permitted to pre-pay the loans, and even if there existed a pre-payment clause, the borrower's pre-payment was still prohibited if they did not have sufficient forex revenues and therefore needed to purchase forex funds to discharge their obligations. According to relevant sections of the new rules, if satisfying relevant conditions (which are the approval of the State Council on the pre-payment, debt restructuring or close of the borrower due to national industrial policy changes that make the pre-payment necessary, or a pre-payment required by a court judgment), the borrowers can purchase forex funds to pre-pay the loans.

No Turning Back

In the early 1990s, the Chinese government was quite aggressive in its commitment and adherence to a timetable to abolish forex controls. The reform process was slowed, and some might argue halted altogether, after 1997 for macroeconomic reasons. But the aim has never been relinquished, and the entry into WTO will definitely give the undertaking a new impetus. It has been public knowledge that the State Council is revising the PRC Administration of Foreign Exchange Regulations that will be based on the national treatment standard and change the fundamental structure of the administrative system, especially that part concerning capital account transactions.

By Kenneth Lu

Fangda Partners, Shanghai

Endnote:

1. The same settlement and purchase system also applies to foreign investment enterprises (FIEs), with the exception that FIEs are allowed to open one to four forex bank accounts, depending on their paid-in capital amount, and to keep certain amounts of forex as cash that does not exceed a cap approved by SAFE.

2. By legislation of July 2001, the Ministry of Foreign Trade and Economic Cooperation has changed its original regulations under which only FIEs can export their own products directly. The new regulations permit all domestic enterprises meeting certain requirements to have direct import/export authority. This can be seen as WTO-mandated change.