Illegal capital flight remains a major threat to China's financial stability, but its threat has been minimized with proposed measures for a looser foreign currency environment.

Scholars also urged for better legal protection of private property rights and reform of the floating exchange rate system to eliminate the potential for capital flight.

"The current rosy macro economy can reduce the incentive for capital to leave, though further reforms to create a more open market environment are needed to basically stem the activity," said He Fan, a senior financial researcher with the Chinese Academy of Social Sciences (CASS).

Guo Shuqing, director of the State Foreign Currency Administration, also claimed last week that with a strong macro economy and the stable renminbi, the incentive to transfer capital overseas for a more favorable interest rate has been weakened.

In China, capital flight refers to the transfer of capital to overseas destinations without the ratification of the country's foreign currency regulators.

After strictly controlling foreign currency outflow for a long time, Guo's administration declared last week that it would introduce a series of new measures for enterprises and individuals to better obtain and transfer foreign currencies.

While praising the new measures for loosening conditions for the overseas business activities of Chinese firms, economists also worry that the move could pave the way for capital flight, already a serious challenge to China's economic development.

Capital: Booming economy foils outflow

The amount of capital that leaves China is difficult to estimate due to its secret and often illegal nature. Some economists estimate the figure for the period 1997-99 at nearly US$90 billion.

Ren Hui, a senior researcher with the State Foreign Currency Administration, the major government organ responsible for curbing the outflow, estimated the amount at US$53 billion.

Even Ren's low estimate is equivalent to more than 30 percent of the total foreign investment into China in the same period.

According to Ren, most of the capital that leaves the country illegally is obtained through corruption or aims to earn profit in overseas markets without ratification of the proper authorities.

"Except the corruption which fosters capital flight, motives of capital escape have been reduced by China's booming economy and the greater chance for investment return here," He of CASS told Business Weekly.

The foreign currency administration officials also reiterated that after a peak period in 1998, when a renminbi devaluation was widely expected, capital flight was largely thought to be on the downturn.

However, without clear legal protection for private property in China, the threat of private entrepreneurs transferring their money overseas is still a concern.

But He said it was not worth worrying about because most private capital flowing overseas would return under the name of foreign investment, which could enjoy favorable tax treatment in China. What is lost during the process is mainly government tax revenue.

Yet Zhong Wei, an economist with Beijing Normal University, argues that the massive amount of private capital flowing overseas is not only sparked by investment but by safety concerns as well.

"The need for a constitutional amendment that adds the principle that private properties are inviolable has become quite urgent to curb private capital outflow," said Zhong during an interview with Business Weekly. "Without the principle, private entrepreneurs always fear their assets are endangered."

On the other hand, Chen Bingcai, a financial researcher with the Institute of International Economics under the State Development Planning Commission, suggested a loosening of foreign currency regulations as a solution to the problem.

According to Chen, a large amount of the capital leaves to seek investment opportunities overseas, but because of China's strict controls on foreign currency, investors have to transfer their money illegally. With a freer environment, most of the capital would return when the domestic market offers more opportunities.

Along with reform of foreign currency regulations, experts recommend the replacement of the current fixed rate policy with a floating foreign currency rate system, which would allow the rate of the renminbi to fluctuate according to the market.

According to He, under the fixed rate system, risks could accumulate and eventually break out when the macro economy deteriorates.

"To avoid the outbreak of risk, a floating rate system which could gradually release risks with market fluctuation is quite necessary," he said. The current stable economy and the sufficient foreign currency reserve offer the best opportunity to carry out the reform.

(China Daily May 28, 2002)