In a follow-up piece, the FT author, Geoff Dyer, notes some idiosyncratic implications of this latest move by the Chinese authorities. Given that China is the world's largest goods exporter, verifying the content and value of exports from China is a Sisyphean task if there ever was one. Moreover, if Chinese exports have been overstated all these years so that exporters could accumulate more yuan, then perhaps the real value of Chinese exports has been overvalued as well. While Chinese export figures are indeed impressive, they may have been artificially boosted by invoicing sleights of hand:
China announced a major strengthening of capital controls last night in an attempt to limit the amount of speculative "hot money" entering the economy and frustrating its efforts to contain inflationary pressures. In an announcement on its website, the State Administration of Foreign Exchange, the country's foreign exchange regulator, said exporters would be required to park revenues in special accounts while the authorities verified the funds were the result of genuine trade. The new system risks becoming a cumbersome burden for exporters such as suppliers of cheap goods to western retailers.
Exporters will now be required to provide documentary evidence that their invoices are based on genuine transactions if they wish to change dollars into renminbi. The regulator said the new computer system for checking invoices would be introduced from August 4. A trial period begins on July 14.
Recent leaked figures showed record inflows of capital entering China over the past two months. Officials believe some money came in illegally after companies exaggerated export revenues. China has become an attractive country for investors and companies because interest rates are now above US levels and the renminbi is expected to appreciate.
According to Reuters, China's foreign exchange reserves increased by a record $114.8bn (£57.6bn) in April and May to $1,800bn. Although it is impossible to calculate how much of that inflow is short-term, speculative capital, the figures were substantially higher than the combined numbers for the trade surplus and foreign direct investment.
The capital inflows have made economic management more difficult because, even though domestic inflation has been high in recent months, the Chinese central bank has been reluctant to raise interest rates for fear of attracting more hot money. Authorities have so far prevented the inflows from causing money supply to grow too sharply by issuing bonds and lifting bank reserve requirements.
There has been a growing discussion among private sector economists about whether the authorities should introduce a large, one-off appreciation of the currency in order to limit speculation. However, most economists believe that the government would be very reluctant to take such a step as parts of the export sector are already suffering badly because of higher costs, including the stronger renminbi.
On the face of it, China might not seem the obvious place to invest at the moment. The local stock market has collapsed, property markets are weak and the interest rate on bank deposits is about half the rate of inflation. Yet that has not prevented a record flood of capital inflows even higher than China's huge accumulation of reserves in recent years. In the first quarter, foreign exchange reserves rose by $154bn (€98bn, £78bn). On top of that, according to usually reliable figures leaked to Reuters, reserves jumped by $75bn in April and $40bn in May to a total of $1,800bn. Given that the inflows far outstrip trade and direct foreign investment, China appears to be receiving vast amounts of speculative "hot money".
China has two big attractions for foreign investors - interest rates are higher than in the US and the currency is expected to appreciate. "China's FX reserves seem to have turned into some kind of massive black hole for the world's liquidity," says Stephen Green, economist at Standard Chartered. The huge armoury of reserves was actually designed to withstand the volatile capital flows that helped cause the 1997 Asian financial crisis. However, ever-mounting reserves bring their own economic risks - inflation could be aggravated if the inflows cannot be managed and the financial system could suffer whiplash if investors decide to withdraw funds all at once...
Yet some economists believe the official numbers might actually understate the hot money inflows. As part of the creation of China Investment Corporation, a $75bn-$100bn chunk of reserves was transferred to the new sovereign wealth fund. If most of that transfer took place in the first quarter of this year - as some analysts believe - then the surge in hot money inflows has been even higher. Logan Wright at Stone & McCarthy analysts in Beijing estimates that hot money entering in the first five months could be as high as $150bn-$170bn.
There are plenty of legal routes to bring capital into China. Foreign residents can deposit up to $50,000 a year and Hong Kong residents have a much higher quota. But government officials also believe that illegal transfers are taking place - through foreign companies declaring that funds are for direct investment and then putting the money in the bank and exporters exaggerating the value of overseas revenues in order to bring in extra funds. (As an aside, economists point out that if fraudulent export receipts really are widely used to bring in hot money, China's politically troublesome trade surplus would actually be much lower than thought...)
However companies and analysts were sceptical that the new capital controls would limit illegal capital flows. One exporter in Beijing said that simply checking documents given to the customs would not expose exaggerated invoices: inspectors would need to examine the actual value of the cargo itself to prove fraud. More-over if this new process is rigorously applied, the risk is that it will increase the burden on genuine trade.
China's central bank has faced huge capital inflows for several years and has so far managed to limit the impact on the domestic economy by draining the excess liquidity in the financial system through bonds issues and obliging commercial banks to deposit more money in reserves. However, there are some signs that the system for sterilising inflows is reaching its limit. The higher reserve requirements are putting heavy pressure on some cash-poor, smaller banks. Minggao Shen at Citigroup says that the only countries in the world with higher reserve ratios are Zambia, Croatia and Tajikistan and that Chinese levels cannot go much higher. Moreover, the difference between Chinese and US interest rates means that the central bank is making a loss on its bond issues, which have been rare in recent months.
If the system of sterilising inflows is becoming hard to operate, then the Chinese authorities could find themselves in a trap. Facing inflation at home, the obvious response is to appreciate the currency or raise interest rates. But both those options attract more hot money that will feed inflation. "We are passed the point when there were easy solutions," says Michael Pettis, a finance professor at Beijing University.