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Cross-border trade finance between Hong Kong and China is being hit by Beijing’s capital controls, with government intervention making it “impossible” to get money out of the country.

The Chinese government has made both formal and informal moves to limit the amount of foreign currency that can leave the country, in an effort to protect foreign exchange reserves and to prop up the renminbi (Rmb).

The value of its foreign exchange reserves dipped below US$3tn in January for the first time since February 2011. In January, reserves fell by US$12bn: the smallest drop since April 2015, but the seventh consecutive monthly decline.

GTR understands that across the financial sector, trade finance included, Chinese government officials have introduced checks and controls that are frustrating efforts to conclude deals. This has, according to one source, led to a freeze on trade finance deal-flow between Hong Kong and China.

Dr Bernd-Uwe Stucken, a corporate finance partner at Pinsent Masons in Shanghai, says that the approach is “soft, bureaucratic, that doesn’t require any legal changes”.

He explains that in Shanghai, the State Administration of Foreign Exchange (Safe) summoned a number of commercial banks and told them that there would be internal government approval for specific corporate transactions.

“If it’s a legal transaction, they said they will approve. So the whole process started. The problem is you don’t know when they decide. Apparently for the transactions that need internal approval you need thousands and thousands of officials to do this, who might not even exist. Practically, certain types of payments got stuck. The shock is that this very soft, indirect Chinese approach is still working.”

Stucken works mainly in the areas of dividend payments, M&A transactions and shareholder loans. He says that earnings season will show how much the government has clamped down on dividend payments, but that in other parts of China, even interest payments on shareholder loans have been stopped.

Others have spoken of the direct impact these controls are having on trade finance. Jolyon Ellwood-Russell, a trade finance partner at Simmons & Simmons in Hong Kong, suggests that similarly informal controls are at work in trade too.

“‎For trade, there has been no specific policy as such, nothing explicit from the authorities. But it is well documented that banks have been warned to restrict the amount of money going out on the capital account and that is inevitably having an effect on the current account. I am sure they have been told not to issue standby letters of credit, which is making it difficult for cross-border trade and payments,” he tells GTR.

Banks have been, perhaps understandably, reluctant to discuss their dealings with Chinese regulators at this time of great uncertainty. However, one senior trade banker, also based in Hong Kong, said under conditions of anonymity that the volatility in play since the US election has hastened China into action, but that Safe’s “clampdown on banks to restrict corporate from cross-border arbitrage without valid international trade” has been ongoing for more than a year.

Furthermore, a number of official policies this year have served to strengthen China’s grip on capital controls. On January 1, Safe stepped up its scrutiny on individual foreign exchange purchases and strengthened punishment for illegal capital outflows.

Then on January 25, the China Banking Regulatory Commission (CBRC) ordered commercial banks to strengthen their control and management of funding for outbound investment. Included in this was a directive to improve supervision of anti-money laundering activity, but the general view is that controlling the flow of capital was the main objective.

There is hope, however, that China’s “soft” approach to many of these controls signals short-term ambitions. China is clearly concerned about the outflow of currency and has taken drastic action to stem it. But the fact that little has been written into law gives it the flexibility to reverse the controls with minimal regulatory manoeuvring.

“In the short-term stricter capital controls can be expected to remain in place until the downward pressure on the currency decides and the foreign exchange reserve stabilises. The desire to internationalise the Chinese currency however, will eventually lead to a relaxation of capital controls,” says Max Zenglein, a research associate at the Mercator Institute for China Studies (Merics).

Indeed, the fact that the decline in January was the lowest in more than 18 months suggests that the controls are having the desired effect. Julian Evans-Pritchard, a China expert at Capital Economics, says that the “jitters surrounding capital outflows late last year have subsided” with the latest data, and that the Rmb should strengthen over the course of the year.

Across the board, however, there is real surprise at China’s actions. “Clients in the first place didn’t react, they were shocked. For two weeks they didn’t think that China could turn the clock back and introduce capital controls,” Stucken says.

Earlier this month, GTR reported that the government’s intervention in Rmb markets had led to it falling out of the top five currencies for international trade payments. In 2016, payments in Rmb declined by a massive 26%.

This followed China’s erstwhile aggressive push to liberalise and internationalise the currency being placed on the backburner, with the Rmb facing its worst year since it was unpegged from the US dollar in 2005.