China has tightened its capital controls, in a sharp reversal of its market liberalising rhetoric, as it struggles to contain the fallout from last month's devaluation of the renminbi.

The devaluation unleashed turmoil on global stock markets and policy confusion at home, forcing the central bank to spend up to $200 billion to support the currency. The prospect of an interest rate rise in the US has further encouraged capital flight.

The State Administration of Foreign Exchange (Safe), the unit of the People’s Bank of China in charge of managing the currency, has in recent days ordered financial institutions to strengthen controls on all foreign exchange transactions, according to an official memo.

The Safe has ordered banks and financial institutions to pay particular attention to the practice of over-invoicing exports, used to disguise large capital outflows. The administration confirmed the existence of the memo, but declined to comment further.

China has long imposed limits on the amount of foreign exchange that can be bought or sold by individuals and companies, but those controls have broken down in recent years as the renminbi has become more widely used around the world.

Policy reversal

The policy reversal comes after China’s central bank drew heavily on its vast foreign exchange reserves to prevent the renminbi falling dramatically against the dollar in the wake of the technical devaluation last month. Although still the largest in the world, its reserves fell by the biggest amount on record in August, dropping $94 billion to $3.56 trillion.

For the first time since it began internationalising its currency a few years ago, the central bank has also been intervening heavily in the offshore renminbi market to narrow the gap between the onshore (CNY) and offshore (CNH) exchange rates.

Analysts say Beijing has spent up to $200 billion defending the currency, but the net impact on the reserves is disguised by fluctuating valuations of reserve assets and other inflows into the reserves.

“They have gone from a credible peg that cost them almost nothing to a weak peg that is costing them more than $10 billion a day to defend. They’re paying huge sums for something they had for free just a few weeks ago,” said one person with close ties to China’s central bank.

Within the government, the decision to move on the currency so soon after the bursting of an enormous stock market bubble is now widely regarded as a policy misstep.

(Copyright The Financial Times Limited 2015)