China forex regulator tightens controls to stem capital outflows, sources say

SHANGHAI/HONG KONG (Reuters) - China is stepping up measures to stem capital outflows after the yuan currency skidded to more than eight-year lows, sources said on Tuesday, taking aim at outbound investments that have soared to a record high.

The State Administration of Foreign Exchange (SAFE) has begun vetting transfers abroad worth $5 million or more and is stepping up scrutiny of major outbound deals, including those with prior approval, sources with knowledge of the new rules told Reuters.

Capital outflows through both legal and illegal channels have added pressure on the yuan. The Chinese currency has depreciated nearly 6 percent against a strong dollar so far this year and many traders are betting on further losses, raising the spectre of more capital flight.

The new rules would apply to transfers abroad under the capital account for transactions such as portfolio or foreign direct investment, and could knock some momentum from China's overseas asset shopping spree, analysts say.

Chinese outbound investment deals totalled $530.9 billion in the first nine months of 2016, surpassing 2015's record volume and helping China outstrip the United States as the top acquirer for foreign companies, according to Thomson Reuters data.

"The new rules will have a very big impact on outbound deals," said Luke Zhang, a partner at Zhong Lun Law Firm, who expects the number of deals to go down "quite a lot".

SAFE did not respond to a Reuters request for comment.

"Previously, only forex transfers worth $50 million or more needed to be reported to SAFE. Now, the threshold has been drastically lowered to $5 million, and covers both foreign currency and yuan," said one of the sources with direct knowledge of the rules.

"All we can do is to ask clients to be patient, and tell them that the transaction is being vetted by SAFE for authenticity and may not be approved."

One of the sources said that even if an outbound investment had already obtained approval to buy foreign exchange, but the money had not been fully transferred, the remainder of the quota was now subject to further approval if it exceeds $50 million, which is regarded as a "large sum".

Two other sources confirmed the new rules.

The sources said the forex regulator told banks about the new rules on Monday, the same day the government said it would stick to its "going out" strategy of encouraging outbound investment.

DEFENDING THE YUAN

To prevent the yuan from falling too rapidly against the dollar, China has been using its foreign currency reserves to defend the currency's value, managing expectations in the market, and restricting money outflows into overseas securities.

Wang Zhenying, a senior Chinese central bank researcher, said in a recent interview that Beijing needs to stem outflows which risk putting the yuan into a potentially destructive feedback loop.

"At the moment, the fall in the yuan's exchange rate is shaping market expectations. Depreciation triggers capital flight, and capital flight exerts even bigger pressure on the yuan," Wang said.

"Therefore, it's necessary to break this feedback loop... for example, by slowing capital outflows," he said.

Chinese state-owned banks were seen selling dollars in the onshore foreign exchange market for a second straight day on Tuesday, in what traders said appeared to be a bid to support the yuan.

The yuan has rebounded around 0.5 percent in the past few sessions.

While still the largest in the world, China’s foreign currency reserves have fallen to $3.17 trillion at the end of September from a $3.99 trillion peak in June 2014, indicating that Chinese authorities sold dollars to prop up the yuan's value.

Selling of the yuan and other emerging market currencies has intensified since Donald Trump's upset presidential victory on Nov. 8. Expectations of higher fiscal spending and interest rates under a Trump administration have boosted U.S. bond yields and the attractiveness of the dollar.

(Reporting by Samuel Shen and John Ruwitch in SHANGHAI and Carol Zhong at Basis Point in HONG KONG; Editing by Ryan Woo and Kim Coghill)