Download Capital Account Liberalisation and China`s Effect on Global Capital

Capital Account Liberalisation and
China’s Effect on Global Capital Flows
Alfred Schipke*
1.Introduction
In 1993, China announced a plan to fully liberalise its capital account by 2000. That plan was,
however, disrupted by the Asian financial crisis. China’s capital account liberalisation process
has resumed over the past few years, raising the question about the sequencing of capital
account liberalisation. The debate gained prominence following the renminbi depreciation in
August 2015 and subsequent capital outflow pressures (Figures 1 and 2). This paper provides a
brief overview of China’s capital account liberalisation, evaluates the effect of a full liberalisation
of the Chinese capital account and describes how China’s liberalisation process compares with
the International Monetary Fund’s (IMF) institutional view.
Figure 1: Chinese Renminbi
index
yuan
Fixing rate(a)
(RHS, inverted scale)
106
6.1
104
6.2
CFETS index(b)
(LHS)
102
6.3
100
6.4
98
6.5
96
94
6.6
Spot rate(a)
(RHS, inverted scale)
M
J
2015
S
D
M
2016
J
6.7
Notes: (a) Yuan per US$
(b) 31 December 2014 = 100
Sources: Bloomberg; CEIC Data; China Foreign Exchange Trade System; RBA
* The author is from the IMF. The views expressed here are those of the author and do not necessarily represent the views of the IMF
or those of its Executive Board. This paper is based on Bayoumi and Ohnsorge (2013) and Habermeier et al (forthcoming).
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Figure 2: Foreign Currency Reserves
US$b
US$b
Stock
4 000
4 000
3 000
3 000
2 000
2 000
US$b
US$b
Monthly change
75
75
0
0
-75
-150
-75
2010
2012
2014
2016
-150
Sources: CEIC Data; RBA
2.
Capital Account Liberalisation in China
China has gradually opened its capital account, but considerable restrictions on capital flows
remain in place. According to the IMF Annual Report on Exchange Arrangements and Exchange
Restrictions, 52 out of the 58 items still have some degree of control (IMF 2015).1 The different
types of private capital flows – direct, portfolio investment and other – have been liberalised at
different rates and restrictions on inflows have generally been eased before those on outflows.
Despite formal restrictions, leakages have increased.
Foreign direct investment (FDI) has dominated capital inflows to China, in part because they have
been less restricted than other forms of capital flows (Figure 3). The size of other flows, which are
mainly banking related, have increased in recent years and have been a particularly important
component of capital outflows. By comparison, portfolio investments remain limited, reflecting
greater restrictions on these flows. While portfolio investors have generally been restricted by
various schemes, the allowable quotas for these schemes have been gradually relaxed (Table 1).
1 China’s State Administration of Foreign Exchange (SAFE) measures suggest that, of the 40 items in the capital account, 5 are
unconvertible and 18 are partly convertible.
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Figure 3: Capital Inflows and Outflows
Per cent of GDP
%
%
Gross capital inflows
6
6
3
3
0
0
-3
-3
%
%
Gross capital outflows
6
6
4
4
2
2
0
0
-2
1990
1995
Direct investment
2000
2005
Portfolio investment
2010
-2
2015
Other investment
Notes:Gross inflows are defined as the sum of inward foreign direct investment, portfolio liabilities
and other investment liabilities in the balance of payments statistics; gross outflows are
defined as the sum of outward foreign direct investment, portfolio assets and other investment
assets
Source: Thomson Reuters
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Portfolio inflow
RQFII
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Equity inflow
Northbound
2014
2014
2011
2002
2006
Start year
No
na
No
No
na
No
US$1b
No
(b)
CNY412b
US$79b
US$90b
Cap on
individual
quota
No(b)
Yes
Yes
Yes
Total
quotas
allotted
CNY300b(b)
CNY250b(b)
No
US$150b
No
Cap on
total
quotas
No
CNY0.5m
No
US$2m
No
Minimum
investment
required
CNY
CNY
CNY
Any
Any
Currency
Notes: QDII denotes Qualified Domestic Institutional Investor, QFII denotes Qualified Foreign Institutional Investor and RQFII denotes renminbi QFII
(a) Southbound refers to investment flows from Shanghai (mainland) to Hong Kong SAR, northbound refers to investment flows from Hong Kong SAR to Shanghai (mainland)
(b) Though Shanghai–Hong Kong Stock Connect (SHKSC) investors are not subject to individual quota limits, they are subject to a daily limit and an aggregate quota on total flows; net
southbound flows are capped at CNY10.5 billion per day and net northbound flows are capped at CNY15 billion per day
Source:IMF
Equity outflow
Southbound
SHKSC(a)
Portfolio inflow
QFII
Target flows
Portfolio outflow
QDII
Scheme
Quota
limit
Table 1: Summary of China’s Schemes to Ease Controls on Portfolio Investments
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To gauge the direction of future reforms, it is useful to consider where China stands relative to
other economies. Internationally, higher income per capita tends to be associated with a more
open capital account (Figure 4). China appears to be an outlier, with a more closed capital
account than other countries that have a similar income per capita. Similarly, China has a low
level of integration with the global financial system (as measured by the sum of its external assets
and liabilities as a share of GDP) given its per capita income. This could suggest that China is likely
to become more open and financially integrated with the global economy in the coming years.
Figure 4: De Jure Financial Account Restrictiveness and Income Level
1.0
China
de jure index
0.8
0.6
0.4
0.2
0.0
5
6
7
8
9
10
log of GDP per capita
11
12
Notes:185 IMF member countries, including their territories where data are available; data as at
2014 or latest available
Sources: IMF; World Bank, World Development Indicators
3.
Recent Developments
The volatility in foreign exchange markets, capital outflows and the associated decline in foreign
currency reserves in late 2015/early 2016 prompted the Chinese authorities to better enforce
existing capital account controls and impose some additional measures (such as the 20 per cent
unremunerated reserve requirement (URR)).
Nevertheless, the authorities remain committed to capital account liberalisation and the process
has continued to move forward. In February 2016, the quota for individual institutions to invest
under the QFII program was relaxed and the minimum investment period was reduced from one
year to three months (SAFE 2016). Also in early 2016, access to the interbank bond market was
expanded for international investors (PBC 2016).
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4.
Implications of Full Liberalisation
Given that parts of the capital account remain closed, the question arises of what would be the
impact of fully opening the capital account in one go. The size and direction of those capital
flows could have important implications domestically and internationally. In the past, countries
that liberalised their capital account generally experienced a significant increase in both inward
and outward capital flows (Figure 5). However, with a few exceptions, outflows were larger than
inflows as domestic investors sought to diversify their savings.
Figure 5: Change in Gross International Assets
Five years following capital account liberalisation, per cent of GDP
-10
Venezuela (1996:Q4)
0
Norway (1988:Q4)
0
Canada (1975:Q4)
10
Thailand (1998:Q4)
10
Peru (1991:Q4)
20
Finland (1989:Q4)
20
Colombia (1998:Q4)
30
Japan (1980:Q4)
30
Venezuela (1989:Q4)
40
Germany (1981:Q4)
40
Sweden (1989:Q4)
50
Spain (1992:Q4)
50
Italy (1992:Q4)
60
France (1990:Q4)
60
Chile (1998:Q4)
%
UK (1979:Q4)
%
-10
Source: Thomson Reuters
For China, for example, Bayoumi and Ohnsorge (2013) use a portfolio allocation model and data
from countries that liberalised their capital account over the past 30 years to estimate the size of
capital flows following liberalisation. The authors use a partial equilibrium model that does not
take into account other changes in the macroeconomic environment that would occur if the
capital account were to be fully opened in one step. Nevertheless, the model’s estimates provide
a useful starting point to think about what to expect following capital account liberalisation in
China. Based on this exercise, capital account liberalisation may be followed by a one-time stock
adjustment of Chinese assets of 15–25 per cent of GDP and a smaller adjustment for foreign
assets in China (2–10 per cent of GDP; Figure 6). This would imply a net capital outflow of around
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11–18 per cent of GDP. He et al (2012) and Saadi Sedik and Sun (2012) come to similar results,
estimating that net capital outflows would occur following capital account liberalisation in China.
Figure 6: Predicted Impact of Capital Account Liberalisation on
China’s International Portfolio Assets and Liabilities
Per cent of GDP
%
%
25
25
20
20
15
15
10
10
5
5
0
Assets
Actual (2010)
Liabilities
Net assets
0
Range of predicted change
Note:
Portfolio assets and liabilities exclude official reserve assets
Source: Bayoumi and Ohnsorge (2013)
5.
A Roadmap for Further Capital Account Liberalisation
To date, the sequencing of China’s capital account liberalisation has been broadly in line with the
IMF’s institutional view (IMF 2012) (Figure 7). The liberalisation process has proceeded gradually.
China initially implemented quotas focused on specific investor groups with experiments in
certain parts of the country and over time these experiments have been expanded. Going forward
it would be good to move from quantity-based to price-based restrictions (e.g. Nishizawa 2016).
The process of capital account liberalisation should occur alongside supporting reforms,
including reforms to the domestic financial sector. For China, this would involve the ongoing
modernisation of the monetary policy framework, imposing hard budget constraints and
state-owned enterprise (SOE) reform. Because none of these goals are easily defined, it is difficult
to determine the optimal timing of further capital account liberalisation. As a result, further
opening up of the capital account is likely to occur gradually and in parallel with other reforms.
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Figure 7: Capital Account Opening
Gradual increase
of quotas; relaxing
qualification
requirements
(inflow and outflow
FDI and portfolio)
• Modernising monetary
policy framework
• Implementing hard budget
constraints
• Reforming SOEs, addressing
high corporate debt
•
•
•
•
Deepening of financial markets
Strengthening regulation and supervision
Building up capital and liquidity buffers
Adequate investment regulations
(institutional)
• Contingency plans
Replacing quotas
and qualification
requirements
with price-based
controls (URR or
tax)
• Further strengthening
monetary and exchange
rate framework
• Continued reform of SOEs
and corporate sector
• Enhancing monitoring of
capital flows
• Continued deepening of financial markets
• Introducing net stable funding ratio/liquidity
charges on non-core funding
• Higher risk weights on foreign exchange loans
• Eliminating direct lending
• Expanding regulatory perimeter to shadow
banking/corporate sector
Gradual move
from pre-approval
to registration
and notification
requirement
followed by
reporting
requirement
• Continued improvement
of monetary and exchange
rate framework
• Adequate capital flow
monitoring framework in
place
• Continued deepening of financial markets
• Further strengthening of supervisory and
regulatory framework
Removal of most
controls
• Track record of well-defined
credible monetary policy
and full exchange rate
flexibility
• Adequate supervisory, micro and macro
prudential framework in place
Source:IMF
6.Conclusion
China has made considerable progress in opening the capital account in recent years; however,
it continues to formally maintain significant capital controls and remains more closed than other
economies at a similar level of development. In the future, one would expect China to integrate
further into the global financial system.
If China’s capital account were to be fully opened, there would be both sizable inflows and
outflows. Previous studies suggest that on net there would initially be a capital outflow. In recent
years, China has continued to open its capital account and has indicated that its goal is to move
toward ‘managed convertibility’ (Zhou 2015).
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So far, China has opened up its capital account in a way that is broadly in line with the IMF
institutional view. As this process moves forward, China should move from quantity- to
price-based restrictions, and then also from administrative controls to currency-based regulation
and supervision. One of the challenges going forward is the increasing difficulty of enforcing
the remaining restrictions as the capital account becomes more open and there are more
opportunities to circumvent the rules.
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