China turf war over yuan reform rattles foreign firms

Multinational companies in China say they are being forced to pick sides in a turf war between two major financial regulators fighting over which agency will drive currency and capital account liberalisation.

 

The conflict between the People's Bank of China (PBOC) and the State Administration of Foreign Exchange (SAFE) risks undermining confidence in the country's commitment to pulling down barriers that will finally open up the economy, analysts say.

 

As President Xi Jinping and Premier Li Keqiang try to build confidence in their reformist agenda through consensus and resolution, analysts say the last thing they need is key agencies in charge of critical components of policy being seen as in conflict.

 

"There's a perception, particularly outside of China, that policy is unfolding according to some great plan," said Mark Williams, chief China economist at Capital Economics in London. "Clearly that's never actually been the case, but evidence of conflict within the government will certainly dent confidence."

 

Over a dozen big-name companies are taking part in a range of pilot programmes that allow the free movement of the yuan and capital across China's borders, addressing a common complaint of foreign managers that it is easy to get investment into China but far more difficult to get profits out.

 

The programmes give the companies more freedom than they would otherwise have operating in China, but they also provide the government with a laboratory to test how the economy might cope with the open financial system they have promised to ultimately deliver in order to put the world's second-largest economy on a more sustainable development path.

 

Sources from companies with deep trade relationships with China, inside banks and from foreign business associations, say the conflict between the two massive bureaucracies managing separate clusters of pilot programmes are beginning to impact decision-making at major corporations, which together channel billions of dollars in investment and trade in and out of China.

 

"There are too many pilot programmes in our view," said a treasurer at a major European multinational in charge of deploying systems used to settle company trade in yuan.

 

"There are schemes from SAFE and schemes from PBOC, and they don't like each other. If you sign up for one, you might not be chosen for the other one. So you have to be very careful what you choose and what you say to whom."

 

The treasurer said concerns about being stuck on the wrong side of a fight between powerful bureaucracies - and rumours that other firms had been misled into overinvesting in municipal trials that failed to live up to promises - prompted his firm to limit the amount of capital it committed to trial programmes.

 

Four other sources said they too had been warned of the spat between the PBOC and SAFE, to the extent that the conflict appears to have been an open secret in certain circles of the financial community in China and Hong Kong.

 

"The advice we got was we should participate in one pilot or another because PBOC and SAFE were competing against one another," said a finance executive from a major foreign multinational with close working knowledge of the pilot programmes, adding that multiple sources had given him the same advice.

 

The sources spoke to Reuters on condition of anonymity for fear that speaking publicly would damage the prospects of their businesses in China. SAFE and PBOC did not respond to faxed requests for comment.

 

The root of the conflict between the central bank and SAFE is not clear. Some analysts say the struggle is simply over power, others believe different agendas are at the root of the conflict.

 

"The PBOC is taking a more open approach (to reform), whereas SAFE sees itself as a gatekeeper," said a lead representative of a foreign business association in China.

 

The central bank manages the country's money supply and to an extent has authority over Chinese banks, shared with the China Banking Regulatory Commission. SAFE handles the country's foreign exchange reserves and manages cross-border currency flows. Technically SAFE is under the supervision of the central bank, but in practice analysts say the relationship has been frequently adversarial and agendas have conflicted.

 

TOO MUCH OF A GOOD THING

 

Pilot schemes to test economic reforms locally before rolling them out nationally have been a hallmark of China's development in the past three decades following former leader Deng Xiaoping's slogan: "Cross the river by feeling the stones."

 

After years of breakneck economic expansion, Beijing has said widespread reforms, including fiscal, monetary and legal changes, are needed to secure future growth. It is expected to produce a road map for further economic reforms in October.

 

China's yuan is currently convertible under the current account, the broadest measures of international trade in services and goods. But Beijing maintains tight restrictions on the capital account, worried that freeing up the yuan too quickly could leave the economy vulnerable to rapid movements in capital in and out of the country.

 

It also manages the yuan's exchange rate and domestic interest rates. Many economists see these as key financial reforms, without which China will have difficulty transitioning away from its old state-dominated, investment-intensive economic model toward a more market-driven and globally competitive structure.

 

China has over 10 currency or capital account-related pilot programmes that are active or under development, testing different aspects of liberalisation from simply reducing red tape, to allowing outbound investment and to sophisticated programmes allowing cross border lending and intra-company payments.

 

The publicly announced list of participants boasts some of the largest foreign multinationals in China. They include Royal Dutch Shell , Samsung Electronics <005930.KS>, Standard Chartered Bank and Intel Inc . Major Chinese state-owned enterprises with significant overseas trade and finance operations are also involved.

 

The development of an offshore market trading the yuan in Hong Kong - which is subject to different laws and rules to mainland China - is widely considered a successful example of how a pilot project can work.

 

In China, in addition to pilots managed exclusively by SAFE and PBOC, municipal governments and other central bureaucracies are also starting to enter the fray.

 

In 2012 Qianhai, an area in Shenzhen across from Hong Kong, designated an empty field as a zone for co-operation with the central bank.

 

In June, China's cabinet allowed Shanghai to launch its own "free trade zone" (FTZ), which state media said would trial unspecified currency and capital account reforms.

 

Domestic media have reported that the cities of Tianjin, Xiamen and Guangzhou applied to create similar zones, and rumours of competition between the other institutions involved in the new zones are also rife.

 

FEAR OF COMMITMENT

 

Pei Yigen, head of treasury and trade solutions for Citi China, argued it should not matter much whether the PBOC and SAFE get along. The pilot programmes are different enough in scope so a company should choose the one that fits its needs the best, he said.

 

"Given limited resources, it actually makes more sense for a company to concentrate on one scheme at this stage," Pei said.

 

The more fundamental question when it comes to reform more broadly, says Zhu Haibin, chief China economist for J.P. Morgan in Hong Kong, is whether Beijing is taking a step forward or a step sideways.

 

"My concern is that we are hearing about reform again and again, but we are still waiting for more concrete actions," Zhu said.

 

Sceptical economists have pointed out that China has been committed to opening up its capital account since 1993, yet has failed to follow through; to them the pilots are designed to deliver the appearance of a reform drive devoid of substance.

 

The dilemma for Beijing is that if the scope of a pilot programme is too limited, its success or failure can be criticised as not indicative; but if it is widened to the extent that it serves as a genuine test, massive arbitrage would quickly turn the trial into a de-facto nationwide policy change.

 

There is also the question of a level playing field.

 

"It's a little bit frustrating that if you happen to be headquartered in one city versus another city, you get different treatment," said the finance executive.

 

Others argue the multiplicity of approaches reflects a government deeply divided over what it wants to do.

 

"The Chinese have been playing bureaucratic games for 2000 years. They are pretty experienced," said Andy Xie, an independent China economist who criticises the pilot project approach as outdated.

 

"The meaningful thing is to do something for the whole country, the whole system. Not to open a hole and then put a cap on it," he said.

 

But Xie said that the most important struggle was not between reformist camps within the bureaucracy but between reformers and vested interests that benefitted from the old status quo.

 

By quibbling amongst themselves, Chinese economic reformers are not only putting off key stakeholders, but giving comfort to those who do not want any reform at all.

 

"The only way to change China is to open the dam and allow money to leave." (Additional reporting by Saikat Chatterjee in HONG KONG, Koh Guiqing in BEIJING and the Shanghai Newsroom; Editing by Neil Fullick)