Central bank reportedly drafting tax for FX transactions

A $100 banknote is placed next to 100 yuan banknotes in this October 16, 2010 file picture illustration taken in Beijing. [Photo/Agencies]

China's central bank has drafted rules for a tax on foreign-exchange transactions in a step to stem speculators, according to Bloomberg News.

Known as the "Tobin tax", it is designed to raise the cost for spot currency conversions, and is described by its originator, Nobel-winning economist James Tobin, as "throwing sand in the wheels of speculators". Citing anonymous sources, Bloomberg reported on Tuesday that the initial rate may be kept at zero to allow authorities to refine the rules.

The People's Bank of China didn't immediately respond to request for comments. Vice-governor Yi Gang has raised the possibility on several previous occasions but did not hint whether it would materialize any time soon.

The problem with the "Tobin tax", according to Tommy Ong, managing director for treasury and markets at DBS Hong Kong, is it can't guarantee less volatility in the market since it's difficult to identify if currency trading is due to speculation or the genuine need of companies hedging their foreign-exchange exposure.

The news surprised some observers since the PBOC has won an early victory in its defense of the yuan. Expectation of further depreciation eased when central bank data showed last week that the fall in foreign-exchange reserves was much smaller than in January.

In Hong Kong, the offshore yuan fell 0.12 percent to 6.5189 per dollar on Wednesday, trading around 12 basis points weaker than in Shanghai. After the worst start to a year in two decades, the yuan has strengthened 1.6 percent since Jan 7.

Hedge funds that previously bet against the yuan now are paying a price. According to Bloomberg, at least $562 million of options that pay out if the currency drops below 6.6 per dollar have expired worthless since August. Another $807 million will lapse within three months.

"The Chinese government has proved a stronger adversary than many traders anticipated. ... Bears now face a difficult choice: They can abandon the trade, or hunker down for what could become a costly waiting game," Bloomberg wrote.

PBOC Governor Zhou Xiaochuan said at a Saturday news conference that it is difficult for him to predict movement in the exchange rate, but "despite volatility, calm and normalization always follow a period of turmoil".