China's plans for a tax on currency trading triggered an outcryof criticism about the potential hit to financial markets. Obscuredin the conversation is how the move shows again that the world'sNo. 2 economy isn't content with acceding to a global financialsystem crafted by No. 1.

No major economy has implemented a Tobin tax, a move thatbackers say would curb currency speculation that distortsexchange-rate values. The rules still need central governmentapproval, and it's not clear how quickly they can be implemented,according to people familiar with the matter. The initial levywould be kept at zero to allow authorities time to refine therules, and it wouldn't be designed to disrupt hedging and otherforeign-exchange transactions undertaken by companies, theysaid.

Onehope: A Tobin tax could help curb an outflow of funds from Chinathat last year reached a record $1 trillion. The idea followsChina's use of its leadership of the Group of 20 to examineproposals that would reduce the dollar's dominance. Otherevidence of China's desire to revamp global financial architecturehas been seen in its launch of development banks to rivalestablished lenders such as the World Bank.

“There's a growing sense that China is leading the thinking interms of questioning the value of unsettled capitalflows,” said Tim Condon, head of Asian research at ING GroepNV in Singapore. “Some kinds of flows probably need to berestricted. I don't think China will be the only one.”

Credibility Crash

China's proposal comes at a time when credibility in its policymaking process has been severely dented after a bungled response toa stock market rout in 2015 and after a shock devaluation of the yuan triggered an acceleration inoutflows. Theyuan has weakened about 4.7 percent against the dollar sincethe start of August, and authorities burned through $513 billion offoreign exchange reserves last year to defend the currency, thefirst-ever annual drop.

“Compared with hemorrhaging FX reserves or guerrilla warfarewith speculators, a Tobin tax has some appeal,” BloombergIntelligence economists Tom Orlik and Fielding Chen wrote in anote. “The hope is that a minimal tax applied to all FXtransactions would throw sand in the wheels of speculators, tyingmovements in the yuan more closely to the fundamentals of the realeconomy.”

The other benefit: Controlling the currency would swing from acost in lost foreign exchange reserves to a benefit in the form ofincreased tax revenue, the analysts noted. The catch: Real-worldimpacts are hard to forecast and may prove counterproductive.

In theory, China could implement the tax and still push aheadwith freeing up the yuan, but that's provided its design isn'tconsidered punitive by market participants, according to LouisKuijs, chief Asia economist at Oxford Economics in Hong Kong.

“Internationalizationof the yuan relies a lot on a favorable perception internationallyabout China's financial policies,” Kuijs said. ”It is thuslikely that something like a Tobin tax would be seeninternationally as a setback.”

PBOC Deputy Governor Yi Gang raised the possibility ofimplementing the punitive measure late last year in an articlewritten for China Finance magazine.

“If the PBOC makes it very clear that the Tobin tax will onlyapply to a narrow range of high-frequency capital accounttransactions, it may not be contrary to the spirit of a freelyusable currency,” said Victor Shih, a professor at theUniversity of California at San Diego who studies China's politicsand finance. If the tax is slapped on a wide rage of transactions,it will hurt the yuan's international appeal. “In general, any suchrestrictions only deter investors from holding yuan assets,” hesaid.

Reserve Currency

A promise to let the market have a bigger say in setting theyuan's value was key to China winning approval for entry into the International MonetaryFund's basket of reserve currencies later this year. But sincethat decision was taken in November, China's authorities have spentscores of billions of dollars to fend off speculators who want topush the currency lower and have tightened some capital controls,even as they eased others that allow money to come in.

The PBOC is likely realistic about which transactions it cansuccessfully snuff out by making them more expensive, and has abetter record than the government-led interventions to support thestock market, said ING's Condon.

“The intervention in the currency market is very targeted and,unlike the stock market, by and large they have been successful,”he said.

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