Shi Jianhuai
Since China has made the renminbi convertible for its current
account for a decade, liberalizing the capital account becomes an
increasingly pressing issue for the country.
Financial globalization has evolved to such an extent since the
1990s that the international currency trade is more than 100 times
the commodity trade.
The flow of financial assets across borders is gaining an
increasingly important position in world economic development.
International financial transactions have taken the place of
international trade as the powerhouse for global growth.
Against such a backdrop, it is easy to understand why Chinese
administrative control of the capital account is being
strained.
Liberalizing the capital account would also help China promote
reform in several key aspects.
As required, China's financial sector fully opened after the
five-year transition period for its World Trade Organization
membership came to close in 2006. When the foreign-invested
commercial banks, insurance companies and investment banks offer
financial products and services to clients in China, cross-border
capital flows are inevitable.
The huge capital flows will mean a heavy workload for the
authorities in charge of capital account control. Meanwhile, the
control will probably prevent the country from enjoying the full
benefits from the financial opening-up.
China's economy depends heavily on the outside world after three
decades of opening-up. The total volume of commodity imports and
exports amounted to $1.76 trillion in 2006. The size of the trade
involves massive risks in the country's balance of international
payments.
China's giant trade surplus means that China gains more money
from the commodities it sells than it spends. Because of the closed
capital account, all foreign currencies from the trade surplus must
be sold to the central bank.
Thus, the central bank becomes the major holder of the foreign
currency and the State is pressured for holding the massive amount
of money.
If this right is divided among numerous private owners, they
would manage it with greater efficiency and flexibility. But this
perspective is only possible with a liberal capital account.
More cash in renminbi is used in payment and trade settlement
with other countries. But the Chinese monetary authorities are
reluctant to make renminbi an international currency for fear of
possible shock to the economy in case overseas renminbi cash is
brought into China.
Such fear will be unnecessary if China opens its capital
account. Then the money circulating overseas will mainly be in bank
deposits and not in cash so will not have much influence on the
domestic money supply.
Actually, the scheme of capital account control has been less
strict than it is meant to be due to both internal and external
pressure. As the third biggest trade power in the world, China is
seeing increasingly open trade. The free trade scheme is often used
to facilitate capital flows across the border without being watched
by the authorities. Some international hot money sneaks into
China's capital market with the help of exporters.
The financial opening-up has facilitated such money flows
because the monetary authorities have no way to control foreign
financial institutions in their business details.
The short-term foreign debt has been rapidly rising in recent
years. The major source of such debt is the foreign invested
financial institutions. The strong growth is propelled by the
international expectation of a renminbi appreciation.
Moreover, it is now mission impossible for the monetary
authority to approve every currency trade when the number of cases
is so huge.
A pragmatic choice is to stop administrative control over the
capital account, which is both costly and inefficient, and turn to
a market-orientated governance.
A good example can be found in Chile, where all commercial banks
and financial institutions must hand in a percentage from their
foreign debts as a non-remunerated reserve requirement. The shorter
the debts, the higher the percentage.
Such a policy tool over capital inflow is based on the rule of
the market, which is better than administrative control. And it is
also more flexible because the rate of the reserve requirement can
be adjusted according to actual needs.
A liberal capital account is one of the targets for financial
reform. The key problem is timing the opening of the capital
account, not whether or not it should be opened.
In my opinion, the capital account should be liberalized as soon
as possible once the country is ready. And opening the account
should be done gradually.
China is currently seeing sound economic growth, relatively low
inflation, considerable surplus in foreign trade and fiscal budget,
abundant reserves of foreign exchange and a currency with
appreciating pressure.
China's financial reform has achieved remarkable progress. The
State-owned commercial banks were financially restructured, the
State-held shares in listed companies have been liquidized, a
network of financial supervision has been established, and the
marketization of the interest rate has been largely put in
place.
All these conditions prove that now is a good time for China to
ease administrative control on the capital account and actively
move toward liberalizing it.
The author is a professor with the China Center for Economic
Research, Peking University. The article was originally published
in Economic Observer.
(China Daily June 22, 2007)