China: Forex Regulations - Changes That Impact Inflow And Outflow Of Forex

Last Updated: 29 September 2008
Article by David Tang, Jun Li and Bill Zhang


China promulgated its first Regulations on the Administration of Foreign Exchange ("Original Regulations") in 1996, which were last updated in 1997. One major purpose China promulgated the Original Regulations was to increase its foreign exchange ("forex") reserve. The past decade has witnessed the rapid development of China's economy, including a dramatic change in China's financial situations. Nowadays, China's forex reserve has swung from scarcity to superabundance. As reported by Reuters, China's reserve reached $1,800 billion last May -- the largest in the world. The size of the reserve could be partly attributed to the country's continued trade surplus and sustained foreign investments into China. The arrival of speculative funds, well known as "hot money," is also regarded as one reason for China's enlarged pool of forex reserve. "Hot money" has became a headache for Chinese officials as it causes skyrocketing prices in China's real estate market and fluctuations in capital markets. The Original Regulations seem no longer compatible with China's current needs.

On August 5, 2008, the State Council of China revised the Original Regulations by promulgating the new version of the Regulations on the Administration of Foreign Exchange ("Revised Regulations"), which became effective the same day. This article highlights some of the changes in the Revised Regulations to demonstrate China's new attitude towards forex control and what difference these changes will bring.

Repatriation And Settlement Of Forex Not Required

The Original Regulations required that forex income from current account items and capital account items1 of domestic persons (not only entities but also individuals) must be repatriated back to China2 , and also set forth a mandatory settlement requirement that domestic persons must sell forex to or deposit forex with domestic banks, with limited exceptions.3 These requirements had the effect of increasing China's forex reserve, and their adoption at a time when China had low reserve was understandable.

Under the Revised Regulations, domestic persons can now choose to either deposit forex income overseas or have it repatriated into China.4 For forex transferred back to China under current account items, the Revised Regulations also allow domestic persons to either keep the funds in foreign currency or convert them into RMB.5 The foregoing is generally regarded as the most significant change in the Revised Regulations. However, this change is not as radical as it first appears. Prior to adoption of the Revised Regulations, the State Administration of Foreign Exchange ("SAFE") already provided relief to domestic entities from the mandatory settlement requirement under the Original Regulations.6 In a circular dated August 12, 2007, SAFE allowed all domestic entities to keep their forex income under current account items as needed. That circular ended the earlier requirement of making the amount of forex income from transactions of current account items a domestic person may keep a specified percentage of the amount of forex it had used in the previous year. Thus, with the change, it seems that domestic persons can now open and maintain bank accounts overseas, which were not allowed originally except for listing on a foreign exchange or for overseas construction projects.

Deterring Hot Money Entry Into China

"Hot money" is seen as a driving force for inflation in China, and setting up a firewall against "hot money" is on the top action list in the Chinese regulator's mind. The way to deter "hot money" cannot focus on a single front, and the Revised Regulations are tackling the problem on several fronts.

In the Chapter I - General Provisions, an added provision endows the government with right to take necessary safeguard or control measures to balance between inflow and outflow of forex in case there is or could be serious imbalance or national economy falls or could fall into crisis.7 The Revised Regulations have not articulated what qualifies as serious imbalance or crisis as well as what kind of measures the government might take. In effect, the government has the liberty to take any radical measures as long as it thinks the situation warrants. In reality, to cool down investments in the real estate sector, Chinese government has already adopted certain rules blocking foreign funds into the Chinese real estate market. Foreign invested real estate companies have not been allowed to borrow money offshore regardless of the conventional forex regime pursuant to which a foreign invested enterprise can incur foreign debt up to twice its paid-in capital.

As to "hot money" flowing under the pretexts of import/export transactions, the Revised Regulations mandate that inflow and outflow under current account items must be backed by true and lawful transactions, and banks settling and selling forex must review the authenticity of the underlying transactions and examine the consistency of revenue and expenditures with the transactions.8 Note that bank scrutiny over the authenticity of transactions under current account items is not a new requirement as banks are already so required by SAFE. Nevertheless, it remains to be seen how this stipulation in the Revised Regulations will increase compliance without interfering with or causing delay to regular trade.

As to forex inflow through capital account items, the Revised Regulations have provided that approval of SAFE is required when forex is deposited with or sold to domestic banks unless otherwise provided by the state.9 In addition to SAFE approval when domestic persons convert forex to RMB, which was required under the Original Regulations, now SAFE approval is also required when domestic persons want to keep the income in foreign currencies. Furthermore, the Revised Regulations have a strict prescription that forex from capital account items must be spent with what is approved by SAFE and SAFE will supervise the use of capital account funds, including RMB converted from forex, and the changes in capital accounts.10

The Revised Regulations have a new chapter specifically dedicated to the supervision and administration of forex operations.11 Under Chapter Six - Supervision and Administration, SAFE is empowered with various investigation rights, including on-site inspection of financial institutions or entry into scenes of suspect illegal activities, inquiry of relevant persons and demand for explanations for matters under investigation.12 SAFE can also review and copy transaction documents and other data, and seize the same if they are susceptible to be destroyed.13 With approval by state council or at the provincial level, SAFE can review accounts of persons under investigation.14 While the investigation rights should enable SAFE to better perform its oversight functions, the Revised Regulations, however, fail to provide for any compulsory measures that SAFE can take in case it encounters disobedience during investigation. We would anticipate that practically SAFE will be difficult to compel someone to cooperate with the investigation.

The regime of intensified supervision of forex operations imposed filing obligations on domestic entities engaging in the forex business. These entities must submit their financial and accounting statements and other statistical data to SAFE.15 Should a financial entity have knowledge of any wrongdoing by its clients, it must inform SAFE.16

Encourage Outbound Flows Of Forex

The Revised Regulations take a favorable approach towards outbound forex. Firstly, the Revised Regulations explicitly allow domestic persons to invest in securities or derivatives oversea as well as make direct outbound investments.17 This revision institutionalizes and also expands a pilot project launched last year where SAFE permitted individuals to trade securities listed on Hong Kong Stock Exchange.18 Under the Revised Regulations, now both domestic entities and individuals can trade overseas securities without limitation on the securities traded or the amount involved.

Secondly, the Revised Regulations abolish the verification procedures to certify the source of forex used in outbound investments, which was required under the Original Regulations.19 In accordance with the Revised Regulations, except where specific approval is required by the state, domestic persons only need to register their outbound investments with SAFE.

Domestic persons' capacity to provide guarantee in favor of foreign persons is also increased. The Revised Regulations delete the restrictive stipulation that only financial institutions or enterprises meeting state-imposed requirements can provide outbound guarantee, but only state that SAFE will approve applications for outbound guarantee based on an applicant's asset-liability ratio status unless the state requires special approval.20 It is noteworthy that theoretically domestic individuals can also function as a guarantor of foreign debt. While the change is welcomed, how it will work out in reality is subject to implementation rules yet to be made or updated. The major regulations now governing outbound guarantee have been in place for more than ten years without change and certainly need to be updated to accord with the Revised Regulations.21

Another way forex flows out is through extension of credit by domestic persons to overseas persons, and such lending is explicitly permitted in the Revised Regulations. Unless where the state requires specific approvals, SAFE will "green light "and register outbound lending by domestic financial institutions as long as their business scopes cover this operation; for other domestic entities, SAFE will give its consent based its evaluation of the applicant's assets-liability ratio.22 Note that the Revised Regulations prohibit domestic individuals from lending outwards.


The Revised Regulations reflect China's current priority to balance between inflow and outflow of forex by deterring inflow of destabilizing "hot money" and encouraging outflow of forex surplus. The Regulations, however, serve only as a framework and the language therein are general and abstract. The Revised Regulations are thus most reasonably to be understood as a starting point for promulgation of further detailed implementation rules. How the changes we have discussed above can be carried out to the fullest extent depends on those rules yet to be made. We would not expect the Revised Regulations to bring instant changes, but we still need to understand these Regulations so that we can anticipate what actual changes are in store for the future.


1. "current account items" are defined as ordinary transaction items within the context of international receipts and payments, including balance of payments from trade, labor services, unilateral transfers etc.; "Capital account items" are defined as items of increase or decrease in debt and equity due to inflow or outflow of capital within the context of international receipts and payments, including direct investment, all forms of loans, investments in securities, etc.

2. Articles 9 and 19 of the Original Regulations.

3. Articles 10 and 20 of the Original Regulations.

4. Article 13 of the Revised Regulations.

5. Article 9 of the Revised Regulations

6. Circular concerning Retaining Foreign Exchange Income under Current Accounts by Domestic Entities.

7. Article 11 of the Revised Regulations.

8. Article 12 of the Revised Regulations.

9. Article 21 of the Revised Regulations.

10. Article 23 of the Revised Regulations.

11. Chapter Six. Supervision and Administration, Article 33 to Article 38 of the Revised Regulations.

12. Article 33 (1), Article 33 (2), and Article 33(3) of the Revised Regulations.

13. Article 33 (4) and Article 33(5) of the Revised Regulations.

14. Article 33 (6) of the Revised Regulations.

15. Article 35 of the Revised Regulations.

16. Article 36 of the Revised Regulations.

17. Article 17 of the Revised Regulations.

18. Pilot Projects for Investment in Overseas Stock Markets by Domestic Individuals, issued by SAFE on August 20, 2007. The pilot plan was limited to Tianjin Binghai New District.

19. Article 21 of the Original Regulations.

20. Article 19 of the Revised Regulations.

21. Regulatory Procedures for Provision of Outbound Guarantees by Domestic Entities, issued by People's Bank on September 25, 1996; and Detailed Implementation Rules for the Regulatory Procedures for Provision of Outbound Guarantee by Domestic Entities, issued by SAFE on December 11, 1997.

22. Article 20 of the Revised Regulations.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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