A branch of the People's Bank of China in Hefei, the capital city of Anhui province. The PBOC says China wouldn't face huge risks if it opens up the country's capital account, a goal that was included in the 12th Five-Year Plan (2011-15). [China Daily]

China's capital account liberalization will be a gradual process, as the country needs to improve its ability to address risks such as hot money and asset bubbles, analysts said.

China has made significant progress in capital account liberalization in recent years by gradually easing its grip on its currency as it moves toward full convertibility.

However, some experts have been pressing for faster loosening of the government's strict capital controls.

The latest instance was a central bank report published last week in the Financial News, which said "the time is ripe for the country to open up its capital account."

The report, written by Sheng Songcheng, head of the central bank's statistics department, listed the benefits of capital account opening, including assisting Chinese companies in expanding globally, promoting the internationalization of the yuan, restructuring the economy and increasing household investment channels.

"We might never find an appropriate time to open up a capital account if we wait until conditions mature for interest rate liberalization, currency liberalization and yuan internationalization," the bank official said.

The question of whether reforms will be implemented in the way the report envisions has yet to be answered.

"The timetable in the report cannot be regarded as an official timetable," said Zhao Qingming, a senior researcher with the China Construction Bank.

"The government will be cautious in promoting capital account liberalization, as once you fling the doors open to global capital, it will be difficult to close them," he said.

Higher interest rates for the yuan in comparison to foreign currencies have already been a magnet for overseas capital, leading to an influx of speculative money and arbitrage speculation.

Zhao said the instant loosening of capital account restrictions may attract more hot money, undermining the country's efforts to curb inflation and asset bubbles.

Hot money will often retreat from a country when its economy becomes mired in a recession, contributing to slower economic growth. On the contrary, massive amounts of speculative money will flood into a country when its economy overheats, which can result in asset bubble bursts or even an economic crisis.

China has faced massive cross-border capital inflows in the first half of 2011, driven by expectations of a stronger yuan and interest rate differences between China and other developed economies, according to a report issued by the State Administration of Foreign Exchange late last month.

But the inflow trend was interrupted in the second half of last year, particularly since the end of September, amid a liquidity crunch in overseas markets and reversed expectations for the yuan in offshore markets.

China restricts the movement of money flowing into the country, including investments in real estate, stocks and bonds, to prevent a sudden influx and outflux of capital that could destabilize its financial system.

Such controls have served the country well. They protected China during the Asian financial crisis of 1998 and have helped the country weather the ongoing global financial crisis.

Guo Tianyong, director of the Banking Research Center at Beijing's Central University of Finance and Economics, said that large amounts of overseas capital will enter the country's banking system if the government lifts controls on its capital account, which will increase the availability of loanable funds and help lenders expand globally.

However, Guo also warned of possible risks, including a rise in non-performing loans and bad assets, as well as significant competitive pressure for domestic banks.

Zhao Qingming said China should widen the scope of QDII investment to encourage more domestic capital to be invested overseas.

QDII, or Qualified Domestic Institutional Investing, is a scheme adopted by the country in 2006 that allows Chinese institutions and residents to entrust Chinese commercial banks to invest in financial products overseas.

However, domestic investors have been reluctant to invest overseas in recent years, partly because of limited overseas investment products, expectations for a stronger yuan and higher returns from the nation's real estate sector.

China will also allow more qualified foreign institutional investors (QFII) to invest in the nation's capital markets under the QFII program, Zhao said.