Q&A on the Economy and the Renminbi

Mu Zhiqian，a former consultant to the State Administration of Foreign Exchange，gives his views on the state of the economy，the direction of the renminbi and foreign exchange policies in an exclusive interview with China Forex.

Q:China's economy has often been described as demonstrating "changes amid stability" and showing "worrisome signs among the changes." Do you agree with this assessment? Could you give us your take on "stability," "changes" and "worrisome signs?"

A:Stability is the basis for economic development. New measures to further reform and open up the economy can only achieve their desired results in a stable environment. For China，the top priority is maintaining stability in six crucial areas - employment，foreign trade，foreign investment，domestic investment，the financial markets and market expectations. These areas are interrelated.

Q.What is the management model for the free trade port of Hainan? How much of an opening will we see for the financial sector?

A:The free trade port draws on an internationally accepted operating model. It is designed to give greater freedom to market players，free up their trading methods，and expand the permitted scope of business. Full decentralization at the level of national ministries and commissions，and the gradual implementation of the provincial government's policies will help promote the opening up in a steady and gradual manner，instead of in a chaotic opening all at once. In the financial sector，pre-access national treatment and negative lists are policies that can be anticipated.

In face of changes amid stability，it is important to identify changes，and be wise enough to adapt to those changes. For example，in a complex domestic and international environment，enterprises must consider survival as well as development. They have to tread the delicate path between gains and cost reduction，and weigh profits with risk.

There are concerns over China's economy because of the changing domestic and external environment. Externally，there is uncertainty due to the Sino-US trade dispute. Internally，downward pressures are weighing on the economy. How can these changes be addressed? In respect of foreign exchange and finance，market expectations need to be guided and managed. Additionally，it is essential that we prevent systemic risks. We must  prevent risks from one particular part of the economy creating a bigger crisis.

Q:When the economic situation changes，that often means policy changes are required. What policy changes do you expect to see in 2019 in terms of foreign exchange and the financial system in general?

A:Firstly，let me say something about the likely trends in 2019. We can find some clues from the Davos World Economic Forum. Unlike a year ago，there was an atmosphere of anxiety at the 2019 annual meeting. Economists and entrepreneurs at the meeting were worried，though not entirely pessimistic，about the state of the global economy. They concluded that the one sure thing was rising uncertainty. They saw geopolitical risks as the major concern this year.

Being "neutral" and "counter-cyclical" is a feature of China's foreign exchange and financial policies. Neutrality means adjusting policy in line with changing conditions. Adjustments should be accurate，timely，and measured. Counter-cyclical adjustments are aimed at reducing volatility in the economic cycle. This is inevitable in a market economy.  

Q:What is your view of the steady gains in the renminbi of late? What do you see ahead as far as the Chinese currency is concerned?

A:The recent strength of the renminbi is driven by both international and domestic factors. The main international factors are the weakening US dollar and the halt in the balance sheet reduction by the US Federal Reserve. Domestically，policy shifts have helped stabilize China's economy. Some economic data points have actually suggested a strengthening economy. This is powering the appreciation of the renminbi.

But in a longer term view，there is a high probability that the renminbi will remain basically stable within a reasonable range. A big drop in the currency followed by a period of fluctuations is also possible if we have some unanticipated developments.

Q: The capital account is the current focus of the opening up of the economy. There are some areas of overlap between the capital and current accounts. Can you clarify some of these areas?

A:The key distinction is the separation of fund flows from transactions. For example，if a direct investment is made with physical assets it is still considered to be under the capital account even though it might appear to be a reflection of the flow of goods. On the other hand，profits from a direct investment are considered to be under the current account. But if those profits are reinvested or loaned to others，they will be categorized as being under the capital account. Another example is trade credits. Although the funds are used for imports and exports，these credits are included in the capital account. 

Q:China has improved its regulation of irrational overseas direct investment in sensitive industries. How would you explain "irrational" and "sensitive" in this context?

A:In a bid to give guide and regulate overseas direct investment，restrictions have been imposed on outbound investment in some sectors. These include irregular investment in real estate，hotels，entertainment，and sports clubs，as well as large overseas investments in areas that are not the main business of a domestic company making those investments. Controls are also applied to industrial or securities investment. One aim is to stop investments that are actually just transfers of assets out of China or investment that may be associated with illegal fund-raising. 

Q:Are there any restrictions on profit repatriation by foreign enterprises in China? What is the procedure for reviewing the authenticity of accumulated profits?

A:China has made its current account fully convertible so foreign companies are free to remit profits from China. Remittance can be made through commercial banks. Supporting documents are needed as stated in the Circular of the State Administration of Foreign Exchange on Further Advancing Foreign Exchange Administration Reform to Enhance Authenticity and Compliance Reviews (No.3 [2017]) in Article Seven.

Q:Is there any restriction on the remittance of capital related to stock transfers and exchange?

A:The sale and transfer of shareholdings is dependent on market players themselves. These transactions do not require specific permission from foreign exchange authorities. In cases where foreign shareholdings in a foreign investment project are sold or transferred to a Chinese party，the buyer needs to file an application at his bank before payment can be remitted，as provided in Article Four and Article 22 of Chapter Six in the Operating Guidelines for Foreign Exchange Business under the Capital Account (2017 Edition).

Q:What factors are behind the tightening or easing of regulations governing overseas loans with a domestic guarantee and domestic loans with a foreign guarantee?

A:Policies on overseas loans with a domestic guarantee are adjusted according to management practice，the balance of payments situation and the needs of the real economy. For example，the State Administration of Foreign Exchange has made some policy adjustments as stated in its third and eleventh circulars released in January and November 2017，respectively. The adjustments were made to address problems found in specific types of business in an effort to improve the management of overseas loans with a domestic guarantee，strengthen the cooperative management of related business and foreign direct investment，as well as prevent illegal outbound transfers of assets via overseas loans with a domestic guarantee.

Here are some instances of the changes. Banks are not allowed to directly use funds from counter-guarantees to fulfill contracts anymore. Instead，they need to use their own funds. In addition，where the recourse against the guarantor involves foreign exchange settlements and sales，a report needs to be made to the State Administration of Foreign Exchange. Additionally，banks should review the legitimacy of funds under a counter-guarantee. They also need to review the qualifications of the subject of a guarantee，the primary source of repayments，the likelihood of contract performance，and the uses of the main debt.