The State Administration of Foreign Exchange (SAFE) said on Friday it would allow businesses to keep a bigger part of their foreign exchange earnings to reduce their costs and facilitate the establishment of a voluntary forex settlement mechanism.

Starting from May 1, companies with foreign trade rights will be allowed to retain their current account forex earnings equivalent to 30 per cent or 50 per cent of the previous year's earnings, up from 20 per cent currently, the administration said.

The 30 per cent ceiling applies to companies whose current account forex payments in the preceding year were less than 80 per cent of their current account forex earnings. Otherwise, the 50 per cent ceiling will apply. They must sell the rest to the banks.

"This is a move towards a more flexible exchange rate regime," said Wang Yuanhong, a senior analyst with the State Information Center.

China's mandatory forex settlement system, under which businesses are required to sell all or part of their forex earnings to the banks and buy forex only under circumstances permitted, has distorted the demand and supply of forex, he said.

The Chinese Government has resisted foreign pressure to revalue the local currency, the renminbi, which the United States said is undervalued. Instead, it will gradually adopt a more flexible exchange rate regime.

The current forex settlement system was introduced in 1994. Chinese companies were required to sell nearly all forex earnings from the current account, which largely includes foreign trade and current transfers like remittance by overseas Chinese, to the banks until 1997, when some big State-owned enterprises were allowed to open current account forex settlement accounts and retain part of forex earnings.

The controls were loosened during the past three years. Most companies can now keep an equivalent of 20 per cent of the preceding year's forex earnings, while income from such categories as international project contracts can be fully retained.

While such loosening measures can help businesses reduce commission costs and improve competitiveness, analysts said the moves are also aimed at alleviating the upward pressure on the renminbi by reducing dollar inflows into the banking system.

China's central bank purchases excess dollars with the local currency from banks to enforce a narrow range for the exchange rate. The massive dollar purchases in recent months have led to rapid increases in money supply and fuelled inflationary pressures.

With high speculation that the renminbi may appreciate soon, however, analysts said businesses' greater autonomy over forex matters does little to help reduce dollar sales to the banks for the time being.

Unlike earlier years when Chinese companies were willing to keep every dollar they earned, they are selling every dollar possible to the banks. Most businesses kept the small part of the forex they were allowed last year, sources said.

(China Daily April 17, 2004)