Experts wary of roll-out for liberalisation

In the second part of our series on the yuan, we look at what market watchers are saying about Beijing's plan to open up its capital account

PUBLISHED : Monday, 30 September, 2013, 12:00am
UPDATED : Monday, 30 September, 2013, 4:00am

Market watchers remain sceptical about whether Beijing's targeted time frame for opening its capital accounts, a key step in the yuan's journey to global acceptance, is too soon.

After making its currency fully convertible for trade settlement under the current account, China's key task in globalising the yuan is to promote free capital movements under the capital account.

The central bank is looking to achieve a "basic" opening of the capital account by 2015 and attain full liberalisation by 2020.

However, critics said, no clear timetable has been announced to achieve what a fully open capital account requires - flexible interest and exchange rates.

"With inflexible interest and exchange rates, capital account liberalisation will render monetary policy ineffective and create large welfare losses for China," said Yu Yongding, a former member of the central bank's monetary policy committee.

The yuan's internationalisation can be achieved only when "the exchange rate can adjust constantly around its equilibrium level and domestic interest rates are flexible enough in response to the fluctuations of cross-border capital flows", Yu said.

China's 12th five-year plan said the mainland would gradually open up its capital accounts, and the volume of cross-border capital flows has been growing sharply.

But critics said it remains to be seen how Beijing could stop possible capital flight from the mainland and how its fragile financial system could sustain the attack of "hot money" if the window fully opens.

Beijing boosted the quota for the renminbi qualified foreign institutional investor (RQFII) scheme to 270 billion yuan (HK$341 billion) in March and approved nearly half of that by last month. The scheme allows offshore yuan to be invested in the domestic securities market.

Meanwhile, US$46 billion flowed into the mainland under the qualified foreign institutional investor (QFII) scheme, the equivalent for inbound investment of foreign currency. Shanghai-based Z-Ben Advisors estimates that would double to US$100 billion by the end of next year.

As outbound merger and acquisition activity increases, outward foreign direct investment is expected to rise to about US$5.15 trillion by 2020 from US$311 billion, accounting for 27 per cent of gross domestic product, according to IMF forecasts.

Independent economist Andy Xie told the Post exchange rate liberalisation should not be the top priority for mainland regulators at this moment.

"The nation is having a domestic crisis, and they should handle those problems first," Xie said by phone, warning that opening up too fast would lead to capital flight.

According to IMF calculations, a speedy liberalisation of cross-border capital movements could produce over several years net outflows from China equal to as much as 15 per cent of the country's gross domestic product, roughly US$1.35 trillion.

Of that sum, China would send as much as US$2.25 trillion overseas, while foreigners would invest US$900 billion in China.

That follows the experience of Japan, where 10 per cent of its GDP flowed out of the country in five years following capital account liberalisation.

Capital flows in and out of the mainland are still tightly controlled. For instance, every citizen can take abroad no more than US$50,000 each year. Mainland firms need regulatory approval for every direct investment deal overseas.

Portfolio investment - purchasing bonds and equities - has to be conducted under limited quota schemes, namely the QFII and RQFII for inward flows, and the qualified domestic institutional investor scheme (QDII) for outward flows.

Xu Hao, a deputy director general at the China Securities and Regulatory Commission, told a summit in Hong Kong this month that the QDII scheme is expected to grow rapidly.

He said the government will bring in reforms cautiously.

"Deng Xiaoping had a famous saying, 'crossing the river by feeling for the stones' … we are facing a river and we wanted to make sure that we took our first step towards stone, not to get drowned in deep water," Xu said.