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At the Qianhai economic zone, foreign firms will be able to convert any amount of foreign exchange any time. Photo: Edward Wong

Qianhai currency reform gives hope to China financial liberalisation

Relaxation of exchange controls seen as proof of mainland pressing ahead with financial change

Beijing's relaxation of foreign exchange controls in Qianhai has brought some relief to the market that the mainland is still determined to go through with financial reforms despite some murmurs it may row back on the measures due to worries over potentially large capital outflows.

Foreign firms in Qianhai, the pilot economic zone in Shenzhen, will be allowed to convert any amount of foreign exchange any time they want starting today, the Qianhai authority said in a statement last Monday.

Macquarie economists John O'Connell and Matthew Brooks estimated that the mainland's capital account liberalisation will lead to gross outflows of about US$1.65 trillion and inflows of US$600 billion.

"China's leadership wants to increase the market's role in resource allocation and to make innovation a key driver of growth. We think the new leaders have the political will to push the needed reforms, as shown by their crackdown on corruption," a Macquarie note said.

"What happened in Qianhai is strong evidence that China has no intention giving up their strong stance to push forward reforms even if that means large scale capital outflows and bank earnings may suffer as there are more fundraising tools available," said another banker who is monitoring the situation.

Mainland leaders have said worries over foreign exchange reserves being reduced are overblown or misplaced.

"Frankly speaking, foreign exchange reserves have become a big burden for us," Premier Li Keqiang said in a speech last May.

Qianhai, a 15 square kilometre coastal strip near Hong Kong, was chosen as the testing ground for the free use of the yuan and capital account convertibility four years ago.

Foreign firms in the rest of the mainland still have to submit an application to settle foreign exchange transactions by making payments with the mainland currency. The Qianhai authority's move would help reduce a firm's potential losses due to volatile exchange rate fluctuations.

Concerns had spread that the mainland could turn more cautious on financial reform due to worries over capital flight. Those fears were underscored by reports that a number of mainland banks were helping clients illegally transfer large amounts of capital overseas.

The mainland recorded net overall inflows in the first half of this year, although second-quarter data showed it had changed into a net outflow of capital, the exchange regulator said last month.

In recent years, the mainland's accumulation of foreign exchange has largely been determined by a capital account surplus, which is driven by cross-border rate arbitrage and expectations of yuan appreciation.

Qianhai has also launched a so-called negative list where foreign investment would be allowed in all sectors unless they are expressly prohibited by law or by the government. The zone would also be more aggressive in facilitating the movement of capital in and out of the mainland.

Foreign investment in areas beyond such a negative list will only have to go through record-filing procedures with the relevant authorities, rather than seeking approval with several official agencies. Before Qianhai, only the Shanghai free-trade zone operated with such conditions on the mainland.

This article appeared in the South China Morning Post print edition as: Qianhai currency reform gives hope to liberalisation
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