China’s central bank -the People’s Bank of China (PBC) has indicated that it is considering introduction of tax on short term capital flows to check volatility in its currency. The Yuan is under pressure as capital outflows intensified amidst weak macroeconomic performance.
Tobin tax is a form of capital transaction tax aimed to stop speculative short term capital or otherwise called hot money. It is this short term capital that usually goes to the banking sector, capital market and other financial assets that is quickly withdrawn during a crisis. The tax was previously advocated by economist James Tobin.
In its usual from, Tobin tax is imposed on both inflow and outflow of short term capital. This discourages speculative activities as well as giving enough time to the central bank and other regulators to launch the corrective measures.
According to indications, China is planning to launch the tax in a phased manner. At the beginning, the tax rate will be zero and with rising speculative activities it may be activated.
For China, its currency and financial markets are yet to recover from the recent period of turmoil. Downward pressure on yuan has compelled PBC to intervene in the foreign exchange market – both in mainland as well as in Hong Kong to support yuan. Foreign exchange reserve has fallen by almost 250 billion according to unofficial estimates.
Though yuan was inducted as a reserve currency under the SDR basket of the IMF, stability has been questioned due to steep fluctuations that are uncharacteristic to a reserve currency. Introduction of a capital transaction tax may soften the fluctuations in the foreign exchange market and thus more stability to yuan.