China's forex pitfalls

Beware of using up the foreign exchange debt quota from borrowing foreign loans with a term of more than one year says Baker & McKenzie partner.

According to Article 18 of the Provisional Measures on Administration of Foreign Debts (the "Measures") jointly promulgated by the State Development Planning Commission ("SDPC"), the Ministry of Finance ("MOF") and the State Administration of Foreign Exchange ("SAFE") on January 8, 2003, which became effective from March 1, 2003, the sum of cumulative amount of "medium and long-term", and balance of "short term", foreign exchange debts borrowed by a given Foreign Investment Enterprise ("FIE") is subject to, and cannot exceed, the difference between the amount of total investment and registered capital of the FIE. This difference is often referred to as "the foreign debt quota".

If the total foreign exchange debts exceed the foreign debt quota, the FIE in question will be required to apply to the relevant PRC authorities to increase the total investment amount (and possibly the registered capital as a result) in order to allow the excess of the foreign exchange debts to be registered with SAFE.

The Measures do not define the terms "medium and long-term" or "short-term" foreign exchange debts. However, the term "medium and long-term" (foreign exchange) debts is generally taken to mean (foreign exchange) debts with a term of more than one year, while the term "short term" (foreign exchange) debts is taken to mean debts with a term of one year or less.

Cumulative amount of medium and long term debts

It should be noted that as "medium and long-term" foreign exchange debts are counted on a cumulative basis, such debts, once being borrowed by the FIE and registered with SAFE, would permanently take up the foreign debt quota, which then cannot be re-used for new foreign debt borrowing. Effectively, such debts would permanently reduce the foreign debt quota of the FIE, even after they subsequently have been wholly or partially repaid by the FIE.

Although the measures in respect of medium and long-term debts have been in place for years, it appears that the measures have not been well understood and enforced in practice. This has led to several subsequent notices issued by SAFE requiring the tightening up of the measures.

Practice of SAFE

According our recent inquiries with SAFE and its several local offices, the SAFE practice as to the administration of foreign exchange debt registration by FIEs is consistent with the above position.

Short term debts

Under the Measures, the balance of short-term foreign exchange debts is the amount of outstanding short-term loans or debts of a FIE at a particular given time. If the short-term loan is not yet repaid, it would only temporarily reduce the foreign debt quota. However, Once such debts have been repaid, they would NOT affect or reduce the foreign debt quota.