Taking the reins on capital controls is key to stability

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Vietnam approaches the triangle of impossibility in much the same way as China does. They both implement capital controls in order to pursue their inflation target while maintaining exchange rate stabilisation. In this article, we examine China’s exchange rate management mechanisms and controls regarding inbound foreign indirect investment capital in order to draw parallels with Vietnam.

The most important Chinese legal documents relating to these topics include the “Provision on foreign exchange administration of domestic securities investment by Qualified Foreign Institutional Investors (QFIIs)” or Decree No.1/2009 of the State Administration of Foreign Exchange (SAFE); and Decree No.02/2012 of SAFE to revise some regulations of Decree No.1/2009. In Vietnam, the latest legal document is Circular No.05/2014/TT-NHNN, effective since April 28, 2014. In general, foreign exchange control in China is much tighter than in Vietnam.

Firstly, QFIIs must obtain an investment quota from SAFE and each QFII quota must be for at least $50 million per issuance, which will be valid for at least one year before it can be revised upwards. The principal should be remitted inward to China within six months of the approval date. Should the remitted principal not be the full prescribed amount but in excess of the equivalent of $20 million, the actual remitted amount shall be deemed to be its investment quota. If the principal amount is less than $20 million, exchange settlements and investment will not be allowed.

The principal is subject to a lock-up period, in which the QFIIs are forbidden from remitting the principal abroad. For QFIIs, such as pension funds, insurance funds, mutual funds, charity funds, endowment funds, government and monetary authorities, and open-ended Chinese funds initiated and established by QFIIs, who are preferred by Chinese authorities, the lock-up period of the principal is three months; for other QFIIs, the period is one year.

Secondly, QFII’s are entitled to repatriate investment profits. However, repatriation of principal must be approved by SAFE at the national level. QFII repatriations are capped monthly at a maximum of 20 per cent of the total assets of the fund in China as of the end of the preceding year. SAFE holds the right to adjust the time, amount, and period for the outward remittances of funds by QFIIs in accordance with the situation.

In Vietnam, there are no regulations regarding quota, minimum required amount of capital committed, the deadline of capital remittance, lock-up period or limit of fund repatriation. Consequently, foreign investors have more flexibility and mobility in their scale of investment and capital inwards and transfer outwards.

Thirdly, foreign currency is allowed to be converted into RMB within ten working days prior to the actual investment taking place. In Vietnam, the conversion can be carried out at the will of the investors.

Lastly, funds in a QFIIs’ foreign exchange account and special RMB accounts shall not be used for any purposes other than domestic securities investments. Currently, QFIIs may invest in stocks, bonds and warrants listed on China’s securities exchanges, securities investment funds, stock-index futures (added in 2011) and fixed-income products traded on the inter-bank loan market (added in 2012). QFIIs may participate in initial public offerings of stocks, offerings of convertible debt, and follow-on offerings and allotments of stocks. Pre-approval from the People’s Bank of China (PBOC) may be required to purchase fixed-income products traded on the inter-bank loan market. The deposit rates for the QFIIs’ foreign exchange accounts and special RMB accounts shall be decided by the PBOC.

These provisions bear strong resemblance to Vietnam, where portfolio investment activities are defined to cover a wide rage of investments. It’s also regulated in Circular 05 that each non-resident portfolio foreign investor must execute his transactions through only one indirect investment capital account, which should be opened at one bank. The balance in the account can be transferred to a payment account in VND, but must not be changed into term or saving deposits.

In short, management is tighter in China than in Vietnam, which helps Chinese authorities to better manage the inward and outward transfer of capital and lengthen the stay of foreign portfolio capital, thereby improving the stability of foreign exchange and stock prices.

By Nguyen Thi Thuy Linh Research Department VPBank Securities