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The Full Convertibility of the Renminbi: Sequence and Impact Drafted by Shucheng Liu and Zhijun Zhao Hong Kong Institute for Monetary Research and Economic Institute, Chinese Academy of Social Sciences Research Project Group: Yue Ma Associate Professor, Economics Department, Lingnan University Yak-yeow Kueh Chair Professor, Economics Department, Lingnan University Shu-ki Tsang Professor, Economics Department, Hong Kong Baptist University Matthew Yiu Manager, Hong Kong Institute for Monetary Research 1 This paper was written while we were visiting Research Fellows at the Hong Kong Institute for Monetary Research. We wish to thank the HKIMR for their hospitality and support. The views presented in this paper are those of the authors and do not necessarily reflect those of the HKIMR. 1. Introduction This paper discusses the sequence of the Renminbi’s full convertibility and its possible impact on mainland China’s economy and Hong Kong’s economy. 2 1. Introduction (Continued) China’s entry into the World Trade Organization (WTO) will effectively speed up the full convertibility of the Renminbi. • Foreign banks will be allowed to make corporate loans in local currency within two years of entry • Foreign banks will be allowed to deal with individual Chinese customers within five years after entry. Some people thus point out that these measures mean the Renminbi will soon become a fully convertible currency. We think this viewpoint is incorrect. 3 1. Introduction (Continued) It is because this viewpoint confuses the capital account convertibility with the Renminbi’s full convertibility. It also confuses removing restrictions on transactions with removing restrictions on exchange. The measures mentioned above are just important steps towards removing restrictions on capital account transactions. They are not yet equivalent to capital account convertibility and still far from the Renminbi’s full convertibility. 4 1. Introduction (Continued) The paper is organized as follows. • • • • Section Two focuses on the sequence of the Renminbi’s full convertibility. Section Three develops a general equilibrium model for an open economy. Section Four analyses the possible effects of the Renminbi’s full convertibility on mainland China’s economy and Hong Kong’s economy. Section Five provides the conclusions. 5 2. Sequence of the Renminbi’s Full Convertibility A. A review of the experience of developed industrial countries B. Three stages in the Renminbi’s full convertibility After World War Ⅱ, developed industrial countries stepped towards the capital account convertibility in a relatively cautious way. (See Table 1 and Table 2) 6 Table 1 Currency’s Convertibility in Developed Industrial Countries (In Order of the Time When Establishing Capital Account Convertibility) Countries USA Germany Great Britain Switzerland Japan Australia New Zealand Netherland Denmark France Sweden Austria Italy Belgium Luxembourg Norway Ireland Finland Spain Portugal Greece Iceland Time When Establishing Current Account Convertibility Time When Establishing Capital Account Convertibility 1946 1961 1961 1992 1964 1965 1982 1961 1967 1961 1961 1962 1961 1961 1961 1967 1961 1979 1986 1988 1992 1983 1973 1975 1979 1980 1980 1983 1984 1986 1988 1989 1989 1990 1990 1990 1990 1990 1990 1990 1993 1993 1994 1995 Length of the Interval Between Current Account Convertibility and Capital Account Convertibility (years) 27 14 18 - 12 16 18 2 25 21 28 28 28 29 29 29 23 29 11 7 5 2 12 7 Table 2 Currency’s Convertibility in Developed Industrial Countries (In Order of the Interval Time between Current Account Convertibility and Capital Account Convertibility) Countries Italy Belgium Luxembourg Ireland France Sweden Austria USA Netherland Norway Denmark Great Britain Australia Japan Germany Iceland Finland Spain Portugal New Zealand Greece Switzerland Length of the Interval Between Current Account Convertibility and Capital Account Convertibility (years) 29 29 29 29 28 28 28 27 25 23 21 18 18 16 14 12 11 7 5 2 2 - 12 8 B. Three Stages in the Renminbi’s Full Convertibility There does not exist a uniform or fixed sequence of the currency’s full convertibility due to the differences across countries. At the same time, based on the common practice and basic sequence taken by most countries in the world, drawing on the experience and lessons from other countries’ practice and in view of the fact that China is a large developing country, we believe that a steady and carefully designed sequence is needed. 9 B. Three Stages in the Renminbi’s Full Convertibility (continued) The whole course of the Renminbi’s full convertibility, we think, should be broken down into three major stages in general. Stage One, Adopting current account liberalization. (It was established by 1996.) Stage Two, Adopting capital account liberalization. (It’s currently going on.) Stage Three, Adopting the Renminbi’s full convertibility. (It will take place in the future.) As to the stage of current account liberalization and the stage of capital account liberalization, each should be further broken down into two successive steps. Step One, Removing restrictions on current account or capital account transactions. Step Two, Removing restrictions on current account or capital account exchange, namely adopting current account or capital account convertibility. (See Table 3) 10 Table 3 Sequence of the Renminbi’s full convertibility Stage One Current account liberalization Step One Step Two Removing restrictions on transactions Removing restrictions on exchange It was established by 1996. Stage Two Capital account liberalization Step One Step Two Removing restrictions on transactions Removing restrictions on exchange It’s currently going on. Stage Three Renminbi’s full convertibility It will take place in the future. 11 Stage One Current account liberalization Step One Removing restrictions on transactions Removing current account restrictions on transactions means removing restrictions on current international transactions themselves and still retaining current account restrictions on exchange, i.e. retaining the examination and approval system relating to current account exchange. 12 Stage One Current account liberalization Step Two Removing restrictions on exchange On the basis of having removed some or most of current account restrictions on transactions, a country can further remove current account restrictions on exchange, namely adopting current account convertibility. It means removing the examination and approval system relating to current account exchange and only retaining audit on the authenticity of transactions. According to Article 8, Section 2(a) of the IMF’s Articles of Agreement,current account convertibility means that no member shall, without the approval of the Fund, impose restrictions on the making of payments and transfers for current international transactions. 13 Stage Two Capital account liberalization Step One Removing restrictions on transactions Removing capital account restrictions on transactions means removing restrictions on capital international transactions themselves and still retaining capital account restrictions on exchange, namely retaining the examination and approval system relating to capital account exchange. China has been generally on the process of removing capital account restrictions on transactions. In 1979, it began to reform and open to the outside world. In 1996, it established current account liberalization. 14 After China’s entry into WTO, a number of restrictions on capital account transactions will be lifted. The main measures are as follows: Direct investment aspect: (1) Foreign banks will be allowed to engage in joint ventures immediately upon entry. Restrictions on percentage of foreign equity stakes in banking will be lifted within five years after entry. (2) The new policy would allow multinational corporations to invest in large- and medium-scale state-owned enterprises and to increase their equities above the 49 per cent ceiling on most state-owned enterprises except companies in certain key industries. (3) The new policy would lift restraints on foreign enterprises taking out Renminbidenominated project financing. (4) China will open its insurance sector. Foreign insurance companies would be permitted to hold up to 50 per cent of life insurance joint ventures with local companies immediately upon entry. Foreign non-life insurers would be allowed to hold 51 per cent of Sino-foreign joint ventures upon WTO entry, and would be allowed to establish whollyowned subsidiaries within two years. Geographical restrictions on foreign insurance companies would be phased out within three years of entry. Within five years, foreign insurance companies would be allowed to expand into group, health and pension insurance. 15 (5) China will open other service sectors, including telecommunications, trade and tourism besides banking and insurance. (6) The new policy would expand the range of services and trade sectors in the western part of China that would be opened to foreign enterprises. Portfolio investment aspect: (7) China has opened the door for foreign venture-capital firms to directly establish such funds. New regulations will allow them to take their venture-capital companies public on the Chinese equity market. (8) Foreigners could invest in the Chinese brokerages in 2004. (9) Foreigners would be allowed to invest directly in the domestic stock market by 2006. (10) A foreign-invested joint-stock limited company which meets requirements would be allowed to issue A or B shares domestically. 16 Other investment aspect: (11) Foreign banks will be allowed to conduct domestic currency business with Chinese firm within two years after entry and then with Chinese individual within five years of entry. (12) Geographic restrictions on foreign banks will be lifted after five years. Foreign banks will be allowed to offer Yuan services in four cities upon accession, with four more cities added each year thereafter. Nationwide market access is due in five years. (13) Foreign banks may capture more than half the domestic market for fee-based banking services such as trade financing, credit card transactions and cash management. (14) Foreign-funded financial institutions would be allowed to provide credit guarantees and foreign-funded enterprises would be permitted to provide foreignexchange collateral. 17 Stage Two Capital account liberalization Step One Removing restrictions on transactions (continued) Note that the measures mentioned above are just important steps towards removing restrictions on capital account transactions. They are not yet equivalent to capital account convertibility and still far from the Renminbi’s full convertibility. For instance, by that time, resident individuals may be able to deposit Renminbi in foreign banks residing in China, but what they can draw from the banks is still Renminbi and not foreign currency. If resident individuals want to draw out foreign currency to pay for capital international transactions, they still need, in accordance with the China’s relevant regulations, to go through the procedures relating to exchange. 18 Stage Two Capital account liberalization Step Two Removing restrictions on exchange On the basis of having removed some or most of capital account restrictions on transactions, a country can further remove capital account restrictions on exchange, namely adopting capital account convertibility. It means removing the examination and approval system relating to capital account exchange and only retaining audit on the authenticity of transactions. Until now, there still exist strict capital account exchange restrictions that need to be lifted up step by step in due course. 19 Stage Two Capital account liberalization Step Two Removing restrictions on exchange (continued) (1) Direct investment Regarding foreign direct investment, some exchange restrictions have been lifted up already. The remaining restrictions are the prohibitions against the remittance of foreign exchanges into China as an investment by overseas legal persons or natural persons. These foreign exchanges could only be settled with the approval of the State Administration of Foreign Exchange (Regulations on the Administration of Settlement, Sales and Payment of Foreign Exchange). 20 Stage Two Capital account liberalization Step Two Removing restrictions on exchange (continued) (1) Direct investment Concerning China’s direct investment exchange restrictions are also very strict. abroad, current Under the existing rules, when making an investment abroad, institutions residing in China shall receive an audit on the source of their exchange capital by foreign exchange administrative agency. (Rules on Foreign Exchange Administration of the People’s Republic of China) 21 Stage Two Capital account liberalization Step Two Removing restrictions on exchange (continued) (2) Portfolio investment With regard to issuing securities to foreigners and opening domestic securities market, exchange restrictions are still very strict. Under the existing rules, foreign exchange received from issuing foreign currency stocks and bonds could not be settled without the approval of State Administration of Foreign Exchange (Regulations on the Administration of Settlement, Sales and Payment of Foreign Exchange). 22 Stage Two Capital account liberalization Step Two Removing restrictions on exchange (continued) (2) Portfolio investment With respect to purchasing foreign securities, exchange restrictions are also very strict. Under the existing rules, institutions and individuals residing in China are forbidden to buy foreign exchange for the purpose of purchasing foreign currency stocks issued abroad. (Circular on Relevant Issues Regarding Perfecting Foreign Exchange Administration Relating to Capital Account.) (Provisional Measures on Foreign Exchange Administration Relating to Individuals Residing in China.) 23 Stage Two Capital account liberalization Step Two Removing restrictions on exchange (continued) (3) Loans For loans, restrictions on exchange are also extremely strict currently. Under the existing rules, without the approval of State Administration of Foreign Exchange, institutions residing in China could not deposit abroad the raised international commercial loans, use them for overseas direct payment or convert them into Renminbi (Measures on the Administration of Raising International Commercial Loans by Institutions Residing in China). 24 Stage Two Capital account liberalization Step Two Removing restrictions on exchange (continued) We can see from the above analysis that on the whole, there is still a lot to do in the removal of various restrictions on capital account transactions and exchange. The removal of restrictions cannot be accomplished in a single action. 25 Stage Three The Renminbi’s full convertibility The Renminbi’s full convertibility means removing in all respects exchange controls relating to the Renminbi, removing audit on the authenticity of current account and capital account transactions and allowing the Renminbi’s convertibility without the occurrence of any real transactions. This clearly could not be established within five years after China’s entry into WTO. 26 3. A General Equilibrium Model for an Open Economy Adopting the Renminbi’s full convertibility will involve a very broad range of areas, including macro-economy and micro-economy, real economic activity and financial activities, internal and external economic balances, price, interest rates and exchange rates, etc. In order to analyze the possible effects of the Renminbi’s full convertibility on mainland China’s economy and to analyze the interaction between the Chinese economy and its foreign counterpart such as Hong Kong, we will develop an open macroeconomic general equilibrium model with micro foundations. Each economy in the model is assumed to be composed of a representative consumer and a firm. 27 The Behavior of a Representative Consumer The objective of a representative consumer is to maximize the present value of his life utilityU t : Ut st [u1 (Ccc,s ) u2 (qs Cch,s ) u3 ( Bcc,s / Pc,s )] s t u4 ( Bch,s qs / Ph,s ) u5 (M cc,s / Pc,s ) u6 (M ch,s qs / Ph,s ) (1) The representative consumer is bound by a flow budget constraint at time t: Ccc,t q t Cch,t (Bcc,t - Bcc,t -1 )/Pc,t q t (Bch,t - Bch,t -1 )/Ph,t (M cc,t - M cc,t -1 )/Pc,t q t (M ch,t - M ch,t -1 )/Ph,t w rc,t -1Bcc,t -1 / Pc ,t q t rh,t -1Bch,t -1 / Ph ,t (2) 28 The Behavior of a Representative Firm The objective of a representative firm is to maximize his profits Pr : Pr A(kcc,t kch,t ) (bcc,t bhc,t )(1 i c,t ) wc,t 1 (35) The representative firm is bound by a flow budget constraint at time t: kcc ,t q t kch ,t bcc ,t bhc ,t (36) 29 Solution: Using the Lagrange function and some assumptions, we get the explicit solution for a representative consumer : C ch , t b cc , t 2 q t b ch , t b ch , t cc , t m ch , t 1 qt (23) 4 1 (1 i h , t ) or m (22) q t 3 1 (1 i c , t ) q t 1 qt 4 1 (1 i h , t ) 5 1 / 1 qt q t 1 qt c ,t 1 6 1 q t 1 / qt (24) (25) (26) (27) h ,t 1 30 Solution: Using the Lagrange function and some assumptions, we get the explicit solution for a representative firm: A k cc , t 1 i c ,t 1 1 A k ch , t ( 1 i c ,t )q t w c ,t 1 ( 1 ) y c ,t 1 A y c , t 1 A [ 1 i c ,t A 1 1 i c ,t 1 1 1 1 (38) A ( 1 i c , t )q t 1 1 q t 1 1 ] 31 4. The Impact of the Renminbi’s Full Convertibility on Mainland China’s Economy and Hong Kong’s Economy A. The Impact on Mainland China’s Economy The above general equilibrium model gives us an analytical framework to study the impact of the Renminbi’s full convertibility on mainland China’s economy. Through model analysis, we will further find that several conditions are necessary for the Renminbi to become fully convertible, including appropriate macro-economic policy, micro-sided enterprise reform, financial system reform, marketoriented interest rate reform and more flexible exchange rate policy, etc. 32 A. The Impact on Mainland China’s Economy The process of the Renminbi’s full convertibility will have an extensive effect on mainland China’s economy. As suggested by the experience of most countries in the world, the most noticeable accompaniment of capital account liberalization will be the massive inflow of foreign investment. 33 A. The Impact on Mainland China’s Economy (continued) In our general equilibrium model, foreign investment inflow is represented by external bond issued by domestic firms, bhc, the solution is given by equation (29). b hc , t h3 1 h (1 i c , t ) (29) In equation (29), (1+ ic,t ) is the real interest rate of the bonds issued at home. Equation (29) indicates that foreign demand for domestic bonds, bhc, is positively related to their real interest rate, (1+ ic,t ) , that is, the higher the rate of return of domestic bonds, the greater the amount of foreign investment in them. This is an important reason for the influx of foreign investment after the opening of capital account. 34 A. The Impact on Mainland China’s Economy (continued) With respect to the effect of massive inflow of foreign investment, we can make an analysis from two angles, namely the effect on real economic activities and the effect on financial activities. We begin our analysis with the effect on real economic activities. 35 A. The Impact on Mainland China’s Economy (continued) The massive inflow of foreign investment, namely an increase in bhc, will cause an increase in domestic capital goods. This is reflected in the equilibrium condition (42) of our model. k cc ,t k ch ,t q t b cc ,t b hc ,t (42) The increase in bhc will lead to the increase in domestic capital goods (including capital goods produced at home, kcc, and capital goods imported from abroad, kch), which in turn, through equation (34) of our model, namely the production function, lead to an increase in domestic output, yc. y c , t 1 A [ k cc ,t k ch ,t ] (34) 36 A. The Impact on Mainland China’s Economy (continued) The increase in domestic output, yc, will, through equation (38), further result in a rise in domestic wage, wc. w c ,t 1 ( 1 ) y c ,t 1 (38) The rise in domestic wage will, through consumers’ budget constraint equation (2), raise domestic consumption, Ccc, and the increase in Ccc will, through consumers’ objective function (1), lead to a higher level of consumers’ welfare and utility. 37 A. The Impact on Mainland China’s Economy (continued) In the above chain-reaction, the most important links are equation (42) and equation (34). The massive inflow of foreign investment will not necessarily increase the real productive capacity of capital and lead to an increase in domestic output. If the large-scale inflow of foreign investment is just in pursuit of profits in the securities market or real estate market, rather than ultimately entering the sphere of real production, bubble economy will result. 38 A. The Impact on Mainland China’s Economy (continued) As a consequence, certain preconditions, including (1) accelerating reform of domestic enterprises with the liberalization of capital account, (2) enhancing the efficiency of domestic enterprises in utilizing foreign investment, and (3) promoting the healthy development of domestic securities market so as to hold the bubble in check effectively, are needed for the conversion of massive inflow of foreign investment into real production capacity which will raise domestic output. Without these preconditions, massive inflow of foreign investment may cause some trouble. 39 A. The Impact on Mainland China’s Economy (continued) We will make an analysis of the effect from the other angle below, namely the effect on financial activities. Massive inflow of foreign investment will lead to an increase in domestic foreign exchange reserve, which will, under the fixed exchange rate regime, result in an increase in the corresponding issuance of the Renminbi. A large increase in domestic money supply will cause inflation and affect real exchange rate. 40 A. The Impact on Mainland China’s Economy (continued) In our model, the formula for real exchange rate is q t e t P h ,t P c ,t (3) We can see from formula (3) that, with nominal exchange rate, e, held constant and with foreign price, Ph , held constant, a rise in domestic price level, Pc, will lead to a fall in the numerical value of real exchange rate, q. For example, when the exchange rate of the US Dollar vs. the RMB changes from RMBY8 / US$1 to RMBY7 / US$1, the Renminbi has actually appreciated. The fall in the numerical value of real exchange rate, q, namely the real appreciation of the Renminbi, will bring a rise in import volumes [See equation (22)(38)] and a fall in export volumes[See equation(28)(39)]. 41 A. The Impact on Mainland China’s Economy (continued) The trend of rising imports and falling exports will cause China to run a current account trade deficit, which will cause a real devaluation of the Renminbi. A severe real devaluation of domestic currency may lead to the massive flight of foreign investment and even to the outbreak of financial crisis. Consequently, in the course of capital account liberalization, the Chinese government should adopt a more flexible exchange rate regime in order to avoid the occurrence of these problems. The whole chain-reaction discussed above is shown at Figure 1. 42 Figure 1 Effect of Massive Inflow of Foreign Investment Foreign investment inflow Capital goods Eq.(42) Output Eq.(34) Eq.(29) Money supply Real exchange rate Eq.(3) Wage Eq. (38) Imports Eq.(22)(38) Consumption Eq.(2) Welfare Eq.(1) Exports Eq.(28)(39) Real value of Renminbi 43 A. The Impact on Mainland China’s Economy (continued) In addition, in the course of capital account liberalization, there also exist some other issues, such as persistently deepening financial system reform, enhancing the competitiveness of domestic commercial banks, pursuing market-oriented interest rate, and strengthening financial supervision. Here in this paper, we do not intend to discuss these issues in detail. 44 B. The Impact on Hong Kong’s Economy The liberalization of China’s capital account and the full convertibility of Renminbi will undoubtedly have a far-reaching effect on Hong Kong’s economic development. The effect can be summarized as follows: 45 B. The Impact on Hong Kong’s Economy (continued) (1) Direct investment aspect: Until now, Hong Kong’s direct investment in the mainland has developed to a certain scale. With the lifting of various restrictions on capital account transactions and exchange, mainland China will provide the flowing-in foreign investment with a wider range of investment opportunities and a better legal and institutional environment, which is conducive to the further expansion of Hong Kong’s direct investment in the mainland. At the same time, the mainland will offer looser conditions for capital outflow, which in turn increase mainland’s direct investment in Hong Kong. Hence it helps promote Hong Kong’s economic development and benefit local employment. 46 B. The Impact on Hong Kong’s Economy (continued) (2) Portfolio investment aspect: When the mainland relaxes various restrictions on portfolio investment, there must be development in the listing of foreign- funded enterprises on the mainland stock market. In addition, more mainland residents could purchase stocks and other securities issued out of the territory. This will help Hong Kong’s firms getting listed in the mainland and enlarge the size of Hong Kong’s securities market. 47 B. The Impact on Hong Kong’s Economy (continued) Recently, that Hong Kong firms’ hope to get listed in the mainland has become a hot issue in Hong Kong. Chief executive of the Hong Kong Monetary Authority, Joseph Yam (2001), once stated his views about this issue on the web page of the Hong Kong Monetary Authority. He came up with some instructive proposals on how the mainland should gradually lift restrictions to enable Hong Kong’s firms to get listed in the mainland. 48 B. The Impact on Hong Kong’s Economy (continued) He (Joseph Yam) also put forward some quite meaningful opinions on how to outline the sequence of financial liberalization. He holds that, on one hand, rules designed to restrict the free flow or use of money are to be broken or to be circumvented so that further steps of liberalization should be taken. On the other hand, decision-makers should be careful about the pace of financial liberalization. Only when the attendant risks have been clearly identified and a prudent risk management mechanism has been put in place should the relevant steps, however beneficial, be taken. 49 B. The Impact on Hong Kong’s Economy (continued) (3) Imports and exports aspect: With the mainland’s accession to WTO and its continuous opening of capital account, the scale of imports and exports of the mainland will be further enlarged. This will offer Hong Kong more commercial opportunities. Thus Hong Kong’s role as a bridge in the field of trade will be enhanced. 50 B. The Impact on Hong Kong’s Economy (continued) (4) Financial service aspect: Just like the co-development of Hong Kong and Singapore in the past few decades as international financial centers; and like the co-functioning of London and Frankfurt, New York and Chicago, which jointly act as financial centers; Shanghai and Hong Kong will join their hands together in playing the role of international financial centers. With the mainland’s entry into WTO, its continuous opening-up of capital account and the future full convertibility of the Renminbi, the overall scale of mainland’s capital inflow and outflow will dramatically be enlarged. This will not only favor the development of Shanghai as a newly rising international financial center, but also offer new and very large room for the further development of Hong Kong as a mature international financial center, due to the inadequacy of the mere reliance on Shanghai. 51 B. The Impact on Hong Kong’s Economy (continued) Influenced by the 1997 Asian Turmoil and the recent slowdown in economic growth in major countries such as the United States, the world financial market is in a phase of adjustment and commercial opportunities will thus diminish. These would drive some Hong Kong-based financial institutions to partly transfer to Shanghai to seek new commercial opportunities. Once the world economy regains its momentum, coupled with the new development of the mainland’s economy, Hong Kong’s financial industry will achieve new and greater development. 52 B. The Impact on Hong Kong’s Economy (continued) (5) New financial derivative instruments aspect: The rapid globalization and intensified competition in global financial market are encouraging constant development of financial innovation. Hong Kong, as a well-grounded international financial center which bears a specific advantage, will play an important role in developing new financial derivative instruments. 53 B. The Impact on Hong Kong’s Economy (continued) (6) Interregional links aspect: Hong Kong is backed by the vast market of the mainland, especially the very large market of some southern provinces adjacent to it like Guangdong that are very closely linked to it in aspects of economy, history, culture and life. These southern provinces, Guangdong in particular, have achieved great development since the mainland’s opening-up and reform, and they are expected to gain further development with the mainland’s accession to WTO and its opening of capital account. This will also offer very large room for Hong Kong’s economic development. 54 B. The Impact on Hong Kong’s Economy (continued) (7) Qualified personnel aspect: With the ever-expanding flow of fund, commodity and information, qualified personnel flow is also getting enlarged. In the presence of intensified competition in financial market, commodity market and service market, qualified personnel will surely play a more important role. In order to retain the favorable position and bring it into full play, Hong Kong should, in the long term, make greater effort in the cultivation of qualified personnel. 55 5. Conclusion I. There does not exist a uniform or fixed sequence in adopting the full convertibility of a currency due to the differences across countries. Based on the common practice and sequence taken by most countries in the world, and in view of the fact that China is a large developing country, we conclude that a steady and carefully planned sequence is needed for the full convertibility of the Renminbi. 56 5. Conclusion (continued) II. The process of the Renminbi’s full convertibility should be broken down into three stages in general: The first one is the adoption of current account liberalization, which was established by 1996; Second, is the capital account liberalization which is currently going on; The third is the adoption of the Renminbi’s full convertibility, which will take place in the future. For the course of liberalization of both current account and capital account, each should be further broken down into two successive steps: First, lifting restrictions on current account or capital account transactions; Second, lifting restrictions on current account or capital account exchange, namely adopting current account or capital account convertibility. 57 5. Conclusion (continued) III. Foreign banks are allowed (1) to handle foreign exchange business towards China’s enterprises in the same year that China enters WTO; (2) to handle the Renminbi loan business towards China’s enterprises within two years after China’s entry into WTO; (3) to handle the Renminbi deposit and loan business towards individuals residing in China within five years after China’s entry into WTO. Some people thus utter that these measures mean the Renminbi will soon become a fully convertible currency. Our analysis shows that this utterance is inaccurate. 58 5. Conclusion (continued) IV. Achieving the Renminbi’s full convertibility will have an extensive effect on mainland China’s economy. By using the general equilibrium model, we find that a series of preconditions are needed for the full convertibility of Renminbi, including appropriate macroeconomic policy, micro-sided enterprise reform, financial system reform, market-oriented interest rate reform and more flexible exchange rate policy, etc. 59 5. Conclusion (continued) V. Achieving the Renminbi’s full convertibility and hence the promotion of mainland China’s economic development will also have extensive effects on Hong Kong’s economy. These effects, generally speaking, are conducive to promoting Hong Kong’s economic development, though it may also exert certain pressure on the transition of Hong Kong’s economy, especially on the cultivation of qualified personnel. 60 5. Conclusion (continued) VI. With the mainland’s entry into WTO and with its continuous opening-up of capital account and the future full convertibility of the Renminbi, the overall scale of capital inflow and outflow of the mainland will dramatically be enlarged. This will not only favor the development of Shanghai as a newly rising international financial center, but also, due to the inadequacy of the mere reliance on Shanghai, offer new and very large room for the further development of Hong Kong as a mature international financial center. The economic recoveries of major countries and the East Asia region, coupled with the new development in the mainland’s economy, will bring new and greater development to Hong Kong’s financial industry. 61 Thank you very much. 62