China’s one-sided capital account controls face backlash as US weighs curbs on investment
- Beijing’s policy of strict controls on outbound capital is facing backlash in Washington and causing potential investors to drag their feet, analysts say
- White House is reportedly discussing ways to restrict US capital flows into China amid ongoing trade war
China’s one-sided capital account controls, which encourage inflows but curb outflows, have started to see a backlash from the United States and institutional investors, a development that could cut the country’s financial links with the rest of the world.
The news came after the investment index provider, FTSE Russell, decided last week not to include China in its flagship World Government Bond Index, meaning the country is missing out on billions of dollars of extra investment each month.
The hallmark of a mature financial market, is that anybody who wants to participate in it can come in and can come out
The decision reflects caution among global institutional investors over China securities, although Bloomberg Barclays began adding Chinese sovereign debt to its aggregate index in April and JPMorgan Chase is expected to start including some Chinese bonds in February.
Marie Owens Thomsen, global head of investment intelligence at Indosuez Wealth Management, said Beijing’s reluctance to offer a two-way investment flow is causing potential investors to drag their feet.
“The hallmark of a mature financial market, is that anybody who wants to participate in it can come in and can come out. Otherwise you're reluctant to go in,” Owens Thomsen said. “If there are limits on how much [money] I can take back out, that's definitely holding people back.”
At the same time, Beijing has little incentive to relax controls on outbound funds when the US-China trade war is putting depreciation pressures on the yuan, analysts said.
The currency has slumped 15 per cent to 7.128 against the US dollar since the world’s two largest economies began a tit-for-tat tariff war 14 months ago.
China has a current account surplus of US$88.2 billion and a financial account surplus of US$45.4 billion, according to the international payment balance report released by the State Administration of Foreign Exchange over the weekend. However, the country reported a huge deficit of US$131.2 billion in the errors and omissions section, showing strong illicit capital outflows.
“Obviously under this fraught trade situation, it's difficult to continue reform,” Owens Thomsen said. “It's going to be very hard to open up the capital account when the currency is weakening, because then I would fear huge outflows,” she added.
Stewart Paterson, a research fellow at the Hinrich Foundation think tank, said China’s political model was a constraint on significant market liberalisation.
[China’s] economic model is that the Communist Party would like to embrace an efficient allocation of resources up to the point at which it doesn’t jeopardise their ability to control
“[China’s] economic model is that the Communist Party would like to embrace an efficient allocation of resources up to the point at which it doesn’t jeopardise their ability to control,” Paterson said. “You need self interested, independent parties acting in good faith under a rule of law. Unfortunately, that’s ideologically antithetical to what the party stands for.”
Meanwhile, Xu Sitao, chief economist and a partner at Deloitte China, said China is doing the right thing by granting better access to foreign investors who would like to tap into a market of 1.4 billion consumers.
“China needs to do many things, but the country is like an onion with so many layers,” Xu said. “Which layer is more important? I think it’s better market access.”
China’s Ministry of Commerce said the country attracted US$89.3 billion in foreign direct investment in the first eight months of this year, an increase of 3.2 per cent; while China’s non-financial outbound direct investment fell 2.5 per cent from a year earlier to US$72.2 billion in the same period.
