© 2015 Prof. Farok J. Contractor, Rutgers University
Permission to Reproduce: A version of this post was published as “The Chinese prefer investing overseas; dummy companies may ease transfers and devalue renminbi” by YaleGlobal Online, September 10, 2015; it was the number-one story in a Google search for “China FDI” that day and is also available as a podcast.
The Sudden RMB Devaluation in August 2015
The global panic in financial markets in August 2015 was catalyzed by the relatively sudden devaluation of the Chinese yuan or renminbi (from 6.2 to 6.4 RMB/$). The Chinese government may have had several reasons for setting the daily reference rate for the RMB at a lower level, for example to signal greater market flexibility or to support its exporters. However, the fact is that enormous amounts of liquid money held by Chinese individuals and companies has—for many years—been anxiously trying to leave China (i.e., leave the RMB as an asset) and park itself in non-Chinese assets such as a Manhattan or Sydney condominium, US stocks, a Singapore bank account, or simply luxury goods. That has created the devaluationary pressure in the exchange markets.
Figure 1: RMB to Dollar Exchange Rate Changes – Summer 2015
Source: Yahoo Finance
The reasons are clear. China is getting richer, and by some accounts (using the World Bank’s implicit estimate for the purchasing power parity [PPP] theoretical exchange rate for the RMB) it may already be coequal with the US as the world’s largest economy. In short, trillions of RMB in liquid assets are trapped inside China. Why trapped? Because the current rules do not allow the Chinese to convert RMB into other currencies without a commercial justification.
A company or individual cannot just go to a bank in China with RMB and ask that they be converted into, say, US dollars. The request would be refused unless the form you fill out shows documentary proof that you are a sanctioned importer, or your child’s tuition in an American university needs to be paid, or that the Chinese firm has a foreign subsidiary that needs funds. In short: you need a provable justification.
Foreign Direct Investment (FDI) Outflows from China and the Difficult-to-Believe Statistics
One stratagem likely used by Chinese companies for getting permission to move funds out of China is to create dummy companies in Hong Kong and the Caribbean. As far back as 2011, the OECD (Organization of Economic Cooperation and Development) reported that as much as 57.4 percent of all outbound FDI capital went to Hong Kong affiliates or subsidiaries, and another 12.7 percent to Caribbean entities. (See Figure 1.) By contrast, Chinese companies’ outflow of FDI capital used to invest in European or US affiliates totaled a mere 8.2 percent.