When Cummins, one of world’s largest diesel engine manufacturers, asked its cash-rich subsidiary in China to contribute funds to headquarters back in Indiana during the worst of the economic downturn in 2009, it received US$200 million. One-third of that amount was in the form of an entrusted loan that will be paid back in three years. Not so long ago, that would have been unthinkable.

Fortunately for Cummins and global companies like it, China’s State Administration of Foreign Exchange (SAFE) has put the simplification of foreign exchange (forex) transactions at the top of its priority list. Also at the top of that list are other measures to help the flow of money into and out of the country, such as increasing the pace of the renminbi’s full convertibility.


In 2009 alone, it enacted a record number of new regulations. They included measures allowing some companies to obtain foreign currency loans. “Overseas investment often requires large sums,” says Mao Zhihao, director for capital accounts of SAFE in Shanghai. “For example, when [Chinese auto maker] SAIC recently invested in Ssangyong of South Korea, the amount exceeded US$500 million.”


It’s under the watch of Yi Gang, a former central bank vice governor who was appointed SAFE’s director in June last year, that SAFE officials, formerly regarded as untouchable administrators of forex-related affairs, are being encouraged to engage more with companies to understand their needs. Meanwhile, SAFE is slowly shifting responsibility for reviewing and processing corporate applications on to the banks so that it can focus more on assessing the investment flows afterwards. But like many other government institutions, SAFE is struggling to deal with the vast flows of commerce sweeping through the country, and much more work lies ahead.

“If you connect all these dots, you can tell that the government is indeed pushing forward investment abroad, although the pace could be bolder,” says Xu Mingqi, a professor at the Shanghai Academy of Social Science.

In a way, SAFE’s moves are about juggling risk and reward, says Mu Zhiqian, editor of SAFE magazine, a SAFE affiliate. “Companies need to build their credit record (in compliance with forex rules) and build trust with [SAFE],” says Mu. “They also need to understand our role too, which is to prevent capital flight and control hot money pouring in.”

Does it mean that the Holy Grail of forex – a fully convertible RMB – will occur soon? “There is no timetable,” says Mu. “What I can tell you is that once you start the acceleration, there is no turning back.”

Forced to Evolve

SAFE has had no choice but to evolve. The cost of regulatory control has already increased to a point that SAFE officials say is too high, while monitoring the ever increasing flow of funds has proven to be almost impossible. Despite strict controls, some US$200 billion of inflows was unaccounted for in 2008. “The high diversity of funds flowing into China makes checking every item impossible,” says Mao.

That is no surprise, given the amount of money involved. In 2008, outbound investment from China was US$18.7 billion, equal to about one-third of its total outbound investment since the country opened its doors to the outside world 30 years ago. Outbound investment in 2009 is estimated to be even higher since many Chinese companies have used the financial crisis to buy assets overseas. However, compared with its US$2.1 trillion in foreign currency reserves, outbound investment remains a small fraction of the total. In the first 11 months of 2009, inbound foreign direct investment (FDI) reached US$78 billion.

The change in attitude at SAFE, modest though it may be, is the result of a major shift in China’s position in global trade when fears of a forex shortage were replaced with fears of a massive surplus. All that began after the Asian financial crisis in 1997, when SAFE was given the mandate to accumulate as much forex as possible. “At the time, we had only about US$100 billion [in forex reserves],” says a senior SAFE official. That’s when the institution launched its policy of — in the words of the official — ‘Welcome inflows of foreign investment but strictly control outflows.’”

Mao recalls the growing concerns at the time vividly. In 1998, he says, a Shanghai company sent an application to SAFE’s office in Shanghai to exchange US$20,000, which it needed for an overseas investment. The company couldn’t find any way to secure the small amount overseas and the deal was on the verge of collapsing. The Shanghai office passed the application to SAFE’s Beijing headquarters for approval, and the request was denied.

Mao then suggested that the company send a team of executives to the country where it was doing business, and have each of them exchange some cash. “It was the only alternative I could think of,” says Mao. “With each member of the team entitled to convert some renminbi into U.S. dollars, they could at least pool the necessary US$20,000 in cash.”

The major shift began in 2004, one year before China loosened the RMB peg to the U.S. dollar. “At the time, the idea was to change from the wholesale welcome of all FDI to balanced management of foreign currency inflows and outflows,” says the senior official. In 2004, SAFE introduced Measure 104 so that, for the first time, qualified foreign companies were able to transfer cash overseas to their headquarters or to related companies via entrusted loans. However, SAFE set the threshold high: The firms needed to have three legal entities invested in China and the funds being sent overseas were restricted to their own local currency. Moreover, approval was required for all cases.

Then in 2005, SAFE launched the so-called Pudong Nine Measures to help multinationals in China as well as Chinese companies with global operations to consolidate foreign currency cash pools and channel excess funds overseas.
In general, SAFE has slowly shifted responsibility for reviewing and processing corporate applications on to the banks so that it can focus more on assessing the investment flows afterwards.

However, these changes were baby steps compared with the rapid changes taking place in business generally. The expectation of gradual RMB appreciation led to inflows of “hot money” seeking high returns, which fuelled asset bubbles in China. At the same time, China’s trade surplus rose dramatically and as a result, its foreign currency reserves, mostly denominated in U.S. dollars, have reached record highs every year since. China’s foreign currency reserves changed from an economic necessity to a hot potato.

One way to alter the balance was to encourage more overseas investment. That’s why since 2006
, fewer overseas investment applications need direct approval from SAFE’s Beijing headquarters – they can be approved by local bureaus instead. Limits on overseas transfers approved by local bureaus also were raised. “In the beginning, the local bureaus could only approve overseas projects up to US$1 million,” says Mao. “Not surprisingly, we’ve seen quite a few US$999,000 projects. But we all know that $999,000 investments don’t make much investment sense.” Those limits have been raised to US$1 billion.

The new policies have had a positive effect, and overseas investment from China has risen steadily ever since. However, the prevention of capital flight remains a major concern and full convertibility of capital accounts (investment-related transfers) is still off the agenda.

A Cautionary Tale

Despite the recent changes, SAFE is hardly treading a revolutionary path. That was made clear in 2007, when SAFE wanted to relax controls on Chinese residents investing in capital markets in Hong Kong. According to the SAFE official, the initiative was halted by banking regulators at the last minute because of rumors that it was fuelling intense speculation in the Hong Kong stock market, sending the Hang Seng Index up 30%. “With that initiative blocked, accelerating the loosening of restrictions on fund movements was hit with a major setback,” says the SAFE official. “No one at [SAFE] dared to mention that [initiative] again.”

The setback illustrates the pitfalls of the liberalization process, says the official. “It showed how small incidents can derail major initiatives and that we all need to be very careful in pushing forward any significant changes,” he says.

SAFE still remains a cautious bureaucracy. “It’s like we opened up the door and windows of our house, but we also placed two guards at the door and a few more guards at the windows to check what’s coming in and going out,” says Mao.