Talk of yuan convertibility in five years is just pie in the sky

Several times in the past couple of weeks, readers have asked me when I think Beijing is going to scrap its remaining exchange controls to make the yuan freely convertible.

The reply most people expect to hear is 'within the next five years'. So they tend to be disappointed with the answer they actually get, which is 'not in the foreseeable future'.

To see why Beijing is not going to relax its capital controls any time soon, we only need to imagine what would happen if the yuan were made fully convertible tomorrow.

With the whole world suddenly to choose from, millions among China's legions of savers would ask themselves whether they could make a better return on their investments elsewhere.

Considering that Shanghai stock prices have fallen 16 per cent in the past 12 months, that the mainland property market is now sinking, and that deposit rates are 2 percentage points below the rate of inflation, which means that savings accounts yield a negative return in real terms, many would conclude that they would indeed be better off investing their savings abroad.

Some have already come to that conclusion. In October, household savings deposits in mainland banks fell by 727 billion yuan, while declines in China's foreign reserves and foreign exchange purchases indicate that money is now flowing out of the economy despite Beijing's capital controls.

If those controls were lifted, the trickle would become a torrent. To stem the outflow, the People's Bank of China would be forced either to appreciate the yuan at a much faster pace or to raise deposit rates to at least a couple of percentage points above the rate of inflation, say to 7.5 per cent.