Withdrawal of foreign funds: the People's Daily's Rebuttal, and the secret leaked

By He Qinglian on September 13, 2013
Source Article in Chinese: 人民日报“十大外资来源地”背后的秘密

China claims to be the world's second largest introducer of foreign investment. Yet when it comes to the origin of foreign investment, there is an embarrassing fact that the Chinese government would not want to admit: a large part of foreign capital is actually Chinese funds posing to be investment from overseas. 

The People's Daily published on August 12 an article saying that foreign funds have not withdrawn from China en masse, and included in it a chart listing the “top ten places of origin of foreign investment in China”. That chart debunked this lie. 

The People's Daily unwittingly leaked a “state secret”

In his article published on August 9, Cheng Xiaonong pointed out that “[f]rom 1997 through to 2008, of the foreign funds introduced into China, those that came from industrialized countries stabilized at about 21 to 25 billion U.S. dollars a year”, while—
[F]oreign funds from Hong Kong, Macao and nine small island nations (British Virgin Islands, Cayman Islands, Samoa, Mauritius, Barbados, Bermuda, the Bahamas, Brunei and the Marshall Islands) grew rapidly every year, shooting up from 20.2 billion U.S. dollars in 2002 to 67.3 billion U.S. dollars in 2008. Once accounting for 38% of the overseas funds introduced into China, hot money came to make up 73% of foreign capital.
Why did Cheng’s analysis end at 2008? That’s because since 2010, the National Bureau of Statistics and the Commerce Department have stopped publishing relevant data on the web. The chart included in the article published on August 12 in the "People's Daily" proved precisely that Cheng was right in his analysis on fake foreign investors in China.

This chart illustrated that from January to June this year, China’s foreign investment came from ten countries and regions, including Hong Kong, Japan, Taiwan, Singapore, the United States, the European Union and others. A total of $ 56.291 billion was introduced.

If, based on the interpretation that chart provided, these funds made up 92.39% of all the foreign capital that entered China, then the total amount of foreign capital introduced to China in the in the first half of this year should be around $ 60.9 billion. Of these funds, $ 39.715 billion was investment from Hong Kong, which accounted for 65% of the total foreign capital.

As Cheng Xiaonong pointed out, current Hong Kong investment in China is mostly done by Chinese capital and can be classified as fake foreign investment. Here it has to be added that the amount of investment from Singapore was $ 3.252 billion, making up 5% of the total foreign capital introduced.

Given that it’s been years since Singapore became the first choice of wealthy Chinese migrants, much of this so-called investment from Singapore was actually a reflux of Chinese funds after they had been bleached.

It is worth noting that 7.61% of the foreign capital did not specify their place of origin. In the following paragraph, the sources of these funds and the reason they hid will be examined.

Tax havens where Chinese funds are bleached 

Washington-based Global Financial Integrity published in December 2012 a report on the outflow of illicit capital. In the report, the organization pointed out that from 2000 to 2011, the amount illegal outflow of funds from China as a result of tax evasion, corruption or crime reached $ 3.79 trillion (approximately 23.6 trillion yuan), accounting for nearly fifty percent of illicit funds flowing out from developing countries and making the China the country with the largest amount of illicit capital outflow.

Where did all this money go? Of course, they were headed to those world-famous tax havens. It is said there are more than 40 such tax havens around the world, the most widely known are the nine small island countries and Cyprus (before the financial crisis occurred there in March this year).

According to an estimate by the International Monetary Fund (IMF) this year, in the decade leading up to 2012, tax evasion and corruption in developing countries resulted in losses of up to $ 6 trillion. These tax havens became the predominant sources of “foreign investment” in the BRIC countries.

Aside from Hong Kong, China’s foreign direct investment (FDI) originated mostly from the British Virgin Islands. The 7.61% of “foreign capital” with unspecified origins in the chart published in the People's Daily was likely to have come from places like the British Virgin Islands.

The rich, business owners and corrupt officials from China, India, Brazil and Russia have all had their respective tax havens (i.e., money-laundering center) that they knew well. The Chinese preferred the British Virgin Islands (BVI); the Indians liked Mauritius; the Brazilians favored the Netherlands; those wealthy Russians who used to see Cyprus as their "private Switzerland" had suffered a major loss this year and will find another place to hide their fortune.

According to revelations by insiders, Chinese tycoons or businesses would set up holding companies in the Virgin Islands, using them to collect funds (typically obtained from sale of stocks or other sources), and they would then bring the money full circle back to China in the form of FDI.

These funds, categorized as foreign investment in China, are actually Chinese capital.

The reasons these funds posed as foreign investment are complex. To evade capital gains tax is one of the considerations, but more important is that they need to be bleached.

The situation of India, Russia and Brazil are not full identical with that of China, but the rich of these countries are using offshore tax havens and faking their money as FDI to avoid domestic tax in much the same way as the Chinese do.

The rapid growth of investment from offshore financial centers has been a notable phenomenon of Chinese capital returning to China after it is bleached. In 2004, China's Ministry of Commerce disclosed in its research report that Chinese offshore companies were registered in nine places such as Hong Kong, British Virgin Islands, and Bermuda.

The way this works is simple, $ 500 to $ 1,000 is spent in offshore financial centers to incorporate companies. After the registration process was completed, these funds would assume a "foreign" status when engaging in business activities in China.

In the first quarter of 2004, the British Virgin Islands, the Cayman Islands, and Samoa ranked second, seventh, and ninth as sources of foreign investment in China respectively.

Some of the Chinese companies that run these offshore subsidiaries are owned not just by people on the street.

On December 26, 2012, Bloomberg mentioned in its investigation “Heirs of Mao's Comrades Rise as New Capitalist Nobility” that at least 18 descendants of the eight most veteran elders of the Communist Party of China (CPC) own or operate entities linked to offshore companies, some of which were incorporated in the British Virgin Islands and the Cayman Islands.

Hong Kong became China’s backyard for money laundering

The last question is: how much money flows from mainland China to Hong Kong each year?

Chinese specialists who study the business of international money laundering called Hong Kong an “intermingled offshore financial center”* that, due to loose policies, is a hotspot where hot money, gray money and illicit money gather.

Data showed that illicit money and gray money flowing from mainland China to Hong Kong accounted for over 10% of the city’s GDP each year. Most of these funds are originated from mainland China.

On February 28, the First Financial Daily published an excellent piece about how money laundering is carried out through Hong Kong.

The report stated that, according to the preliminary calculation by the National Bureau of Statistics, China’s GDP in 2012 was 51.93 trillion yuan. Specialist in money-laundering study Yan Lixin said that, even if a conservative estimate of 2% of the GDP was made, the amount of money laundered in China could exceed one trillion yuan annually. The majority of these funds flow to Hong Kong or through it as a midway transit.

This article described the various money laundering methods mainland Chinese conceived in Hong Kong that touch on almost everything from investment immigration, stock speculation, investment in real estate, to investment in works of art, and antiques. In addition to these methods, many prestigious money launderers with powerful connections took advantages of the loopholes in China’s bid to attract foreign investment and to encourage domestic capital to invest across the border.

Many of the cross-border money laundering organizations that involved dealings with China have ties with state-owned enterprises. The way they work is that, through the establishment of a subsidiary in Hong Kong and other places abroad, these agents made use of the two-way channel with which China’s domestic funds are used to invest overseas and foreign investment are attracted to China to hide or cover up the sources of gray or illicit money.

This observation is in line with what the Global Financial Integrity pointed out in its report, which said that many funds left mainland China for offshore financial centers like Hong Kong and the British Virgin Islands in the form of FDI and then move on to other entities before they moved back to China, posing as FDI that came from Hong Kong and the British Virgin Islands.

In its conclusion, the report said:
This is a sophisticated money laundering system which helps China's high net worth individuals to hide and grow their secret fortune by making use of the relaxed regulations on FDI.
The Hong Kong Monetary Authority issued a "Guideline on the Prevention of Money Laundering", which outlined the three stages of money laundering and the detailed processes of various types of transactions money launderers are engaging in. This is an indication that the Hong Kong authorities are fully aware of the issue.

But in recent years, Hong Kong has become mainland China’s backyard for money laundering. Data showed that money laundering grew more and more rampant in Hong Kong, while the number of people convicted of money laundering was in the decrease. In 2010, the number was 360; in 2011 it fell to 246; and it dropped further in 2012 to 166.

Compared with 2010, the number of persons convicted in 2012 was more than halved.

The above analysis showed that, of the huge foreign capital introduced to China over the years, more than 70% were Chinese capital returning to the country they were bleached—a fact that the government, the rich, corrupt officials and relevant analysts have been fully aware of is treated as “state secrets” for ordinary Chinese people so that the propaganda claiming China to be a big draw for foreign investment could stand a better chance to convince.

*The term “intermingled offshore financial center” (内外混合型离岸金融中心) is defined as a financial center where: 1) It is not necessary for offshore business to set up separate accounts; 2) offshore and onshore accounts can be operated in a consolidated fashion; 3) deposit and loan business for residents and aliens can be operated using the same account; 4) no limit is set for the inflow and outflow of capital; and 5) offshore and onshore financial markets intermingled as one.