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What is the Tobin Tax and why is China discussing it?

A recent Bloomberg article highlighted that China is considering taxing foreign-exchange transactions in an effort to stem record capital outflows. "We are currently studying measures including Tobin Tax, unremunerated reserve requirement and handling fees for foreign-exchange trading to suppress any abnormal and significant flows of short-term funds that seek arbitrage," Wang Xiaoyi, deputy administrator of the State Administration of Foreign Exchange.

The tax gets its name from Nobel laureate James Tobin, who proposed it in 1972 as a means of reducing speculation in global markets. It originally referred to a tax on all spot currency transactions as a means of penalizing short-term currency trading.

It is expected that Chinese officials will discuss a five-year plan for ending currency controls at next week’s Communist Party plenum. However, current capital controls mean the yuan is valued differently in Hong Kong’s offshore market than it is domestically, allowing arbitrage profits for those who have access to both markets for trading. Currently, the currency is 4.1% weaker offshore (Hong Kong) than onshore, as shown in the chart below.

Yi Gang, now China’s central bank Deputy Governor, had written about the Tobin Tax in 2014 in the Communist Party journal when he was head of the State Administration of Foreign Exchange (SAFE).

Since June 2014, China’s foreign exchange reserves have fallen by almost $500B, or 12%.

While such a tax may be effective near term in stemming currency outflows, it will likely spur additional concern of another devaluation in the future.

Ratio of Offshore to Onshore Renminbi (vs. USD)

 

 

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Heidi Learner

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