A Look at Foreign Exchange Reform in China's Special Economic Zones

Since the launch of reforms some four decades ago，the SEZs have spearheaded China's program of opening up its economy to the outside world. The nation's foreign exchange regulator has made full use of these zones for policy experimentation，taking into account both the need for trade and investment facilitation and the prevention of risk.

Following the Third Plenary Session of the Communist Party's 11th Central Committee，SEZs were set up in Shenzhen，Zhuhai，Xiamen，Shantou and Hainan as part of the nation's economic reforms. Over the years these zones have become laboratories and then showcases for economic reform. Ultimately，they were instrumental in the replacement of a highly centralized system of foreign exchange management.

One of the first changes was the introduction of the foreign exchange retention system in 1979 at the outset of the reform program. The aim was to encourage exports and attract foreign investment. Under this system，domestic companies that earned foreign exchange were allocated a foreign exchange use quota that was a proportion of the foreign exchange earned. Approved enterprises were permitted to buy and sell their quota at a market rate. This kind of foreign exchange market system，which had an official exchange rate and a market-based swap rate，was first implemented in Shenzhen，Zhuhai，Xiamen，Shantou and Hainan. As of 1988，all types of foreign exchange earnings could be retained across Hainan province. This measure helped the province – at the time one of the less developed parts of the country – make great strides in its foreign trade. Additionally，regional foreign exchange swap markets，which were confined to over-the-counter transactions，were set up in the SEZs and coastal cities after Shenzhen took the lead in November 1985. The centralized system of foreign exchange allocated by the state was dismantled，and a two-track market approach replaced it.

Before the reforms and opening up policy were put in place，the Bank of China had a monopoly on China's foreign exchange business. In October 1984，the Shenzhen branch of the Industrial and Commercial Bank of China was allowed to take foreign currency deposits and extend foreign exchange loans. In July 1989，China Merchants Bank pioneered offshore business in Shenzhen. In the same year，bank branches or Sino-foreign joint venture banks with their headquarters outside of mainland China were allowed to handle foreign exchange business inside the SEZs.

Moreover，foreign exchange regulations concerning foreign investments in coastal port cities has also been relaxed. In 1984，authorities unveiled the Opinions on Further Relaxation of Foreign Exchange Regulation in Fourteen Coastal Port Cities. According to the circular from China's State Administration of Foreign Exchange (SAFE)，goods sold in China and produced by Sino-foreign joint ventures，Sino-foreign cooperative ventures and wholly foreign-owned enterprises，could be priced and settled in foreign exchange. Foreign parties in these enterprises could invest in their own institutions or other corporations in the same region with their renminbi profits，and the investment would be treated as foreign investment. The profits could also be used to purchase certain goods for export. As for foreign exchange earnings，Sino-foreign joint ventures in special development zones could make use of the earnings within a five-year period.

Special Customs Supervision Zones

Foreign trade became an important driver of China's economic growth as the market economy gained traction. Special Customs supervision zones – such as bonded zones，export processing zones，bonded logistics parks and bonded port areas – were set up. These areas benefited from special policies that let them better utilize resources and tap international and domestic markets. SAFE facilitated the accumulation of foreign exchange by improving the verification system for foreign exchange payments and receipts，and by reforming the management of foreign exchange under the current account.

SAFE's work also included the introduction of foreign exchange regulations in the special Customs  areas. In 1991 and 1995，the Interim Measures for Foreign Exchange Regulation in Bonded Zones and the Measures for Foreign Exchange Regulation in Bonded Zones were issued to regulate foreign exchange registration，foreign exchange account management and the annual inspection of foreign-invested enterprises in bonded zones. In 2000，foreign exchange regulations for the export processing zones were standardized. In 2002，the Measures for Foreign Exchange Regulation in Bonded Zones were updated. In 2007，the various special Customs regulatory areas were brought under uniform  foreign exchange regulations as SAFE unveiled its Measures for the Regulation of Foreign Exchange in Customs Bonded Areas. The regulation scrapped a number of procedures for foreign exchange examination and approval.

More steps were also taken to facilitate trade and investment in the special Customs regulatory areas. When the first bonded zone was set up in 1990，it enjoyed loose foreign exchange regulation. For example，foreign exchange payments and receipts by enterprises operating in the zone did not need to undergo verification for authenticity. Foreign exchange earnings under the current account could be retained by enterprises themselves. By the year 2000，regulations governing foreign exchange under the current account were nearly the same inside and outside of the bonded areas. But the enterprises within these areas enjoyed more relaxed management of their foreign exchange bank accounts and fewer restrictions on foreign exchange purchases. Additionally，business that contributed to regional development received additional preferential policy treatment. In 2005，foreign exchange payments did not have to strictly match the flow of goods – meaning that offshore payments and receipts related to foreign trade were permitted.

Meanwhile，SAFE carried out comprehensive monitoring of the outflow and inflow of foreign exchange，in order to prevent irregular and illegal activity. For instance，during the Asian financial crisis，SAFE stepped up its reviews of foreign trade payments and receipts. The tighter supervision helped stem applications for foreign exchange that made false claims of the intended use of the exchange. The reviews also were aimed at halting illegal arbitrage activities and illegal outbound transfers of foreign exchange.

More Liberal Policies for Free Trade Zones

China launched a new round of reforms in 2013 by setting up the first free trade zone in 2013 — the Shanghai Free Trade Zone. More zones were established during the following years，with  Guangdong，Fujian and Tianjin getting zones in 2015. Seven other zones，including one in Liaoning in the northeast，were established in 2017 and Hainan in the south in 2018，bringing the total to 12. As proposed at the Communist Party's 12th National Congress，free trade zones were granted additional authority to move ahead with reforms in foreign exchange liberalization.

First，there were efforts to streamline administration，delegate authority and upgrade services in order to support the real economy. Foreign exchange payments and receipts from the trade in goods were made more convenient. Enterprises in the zones with the top "A" rating from the foreign exchange regulator could include their foreign exchange receipts in their foreign exchange bank accounts under the current account，instead of having to keep them in a separate export-related account that still had a verification requirement. More multinational corporations were allowed to establish a domestic and an international foreign exchange funds pool at a bank in China. This allowed them to conduct certain transactions such as centralized payments and receipts of foreign exchange funds for current account items. Net settlement was also permitted. Regulation of foreign exchange settlements and sales was improved to help banks carry out over-the-counter transactions of commodity derivatives for customers in the special zones.

Foreign exchange use for investment and financing under the capital account was also made easier. Foreign-invested corporations were allowed to make settlement of foreign exchange capital funds at a time of their choosing. The approval requirements for cross-border guarantees were also eased and prior approval of guarantees and approvals for the payments of fees owed to foreign parties on guarantees were also eliminated. SAFE also supported the development of financing for leasing in the free trade zones. The examination and approval of the creditors' rights of financial leases was scrapped. Eligible financial leasing companies could be paid in foreign currency in China.

Additionally，there were other measures that ultimately were extended nationwide. For example，overseas institutions were allowed to have their foreign exchange settled through a non-resident account. Free trade zones were also encouraged to adopt pilot programs and zones in Guangdong and Sichuan initiated programs to facilitate foreign exchange payments and receipts under the capital account.

At the same time，SAFE took steps to reduce regional and systemic financial risk. Banks were required to examine transactions for authenticity and compliance with regulatory policy. The macro-prudential framework with regular data supervision was established so that irregular capital flows could be uncovered in a timely fashion. In addition，violations of laws and regulations were dealt with more strictly.

China will open its economy further in this new era of reform under the direction of President Xi Jinping. More reform measures will be implemented in these free trade zones，notably in Shanghai，Hainan，and the Guangdong-Hong Kong-Macao Greater Bay Area. These reforms will be aimed at supporting further liberalization of the service sector，particularly financial services. The actual experience in these areas will be reviewed and then applied nationwide – where suitable. The ultimate aim is to support the development of the real economy. In the meantime，the framework with macro-prudential regulation and macro supervision of cross-border capital flows will be improved. At the same time，tight scrutiny will be maintained in order to halt illegal and irregular foreign exchange transactions to ensure economic and financial security.

The author is the chief accountant and director general of SAFE's General Affairs Department