Further Opening up Capital Account

A more open capital account is also a precondition for further internationalization. Among the 43 capital trading categories classified by the IMF, China has 12 of full convertibility and 16 partially liberalized. However, capital controls still exist in some key areas. The rise of overseas RMB stock boosts the demand for RMB investment products; however, the variety and scale of RMB investment products in offshore markets are limited. Therefore there is a pressing need to open up paths for overseas RMB to flow back into the domestic financial market.

In the past few years, China has made many successful experiments in opening up capital accounts. For example, foreign investors can invest in the Chinese stock market through the Qualified Foreign Institutional Investors (QFII) and RMB Qualified Foreign Institutional Investors (RQFII) schemes. Three types of financial institutions from the mainland are allowed to invest in China’s interbank bond market. Cross-border loans are available to enterprises in Qianhai, a financial pilot zone in Shenzhen, and China (Shanghai) Pilot Free Trade Zone.

If capital accounts are not opened up, the RMB that flowed outwards through trade will not be able to flow back smoothly. In the long-term, this will inhibit spending RMB in cross-border trade settlement.

The general guideline of opening up China’s capital accounts is that long-term capital flows should precede short-term capital flows; direct investment should precede indirect; and inflows should precede outflows. Efforts will be enhanced to promote necessary reforms to commercial loans and securities transactions, including bonds and stocks. The goal is to reach full capital account convertibility in three to five years.

As the second largest economy in the world, China boasts a huge financial market with great potential and room for development. The opening up of capital accounts is conducive to the development of its stock, bond, derivative and foreign exchange markets.

Marketization of RMB Exchange Rate

It has been a point of debate in academic circles which should come first – the marketization of RMB exchange and interest rates or opening up the capital account. The mainstream viewpoint holds that opening up capital account first will lead to high flows of arbitrage-motivated capital over short periods, hindering financial stability and national security. Therefore, starting from July 21, 2005, China began to reform the exchange rate regime to raise the marketization level of RMB exchange rates.

The reform includes two aspects: first, the formation of the central parity rate. Since January 4, 2006, the China Foreign Exchange Trade System (CFETS) makes enquiry to market makers before opening the interbank foreign exchange market each business day. It then calculates the central parity rate of the RMB against the U.S. dollar based on a weighted average of all the prices market makers intend to offer. The weight is decided by the CFETS based on the indices such as volume of transaction in the interbank foreign exchange market and quoted prices.

The second reform expands the float range of the RMB exchange rate, from 0.3 percent in the beginning of the reform to the current two percent.

Since the outbreak of the global financial crisis in 2008, developed countries have adopted quantitative easing policies and emerging economies have adopted currency devaluation approaches to expand exports. China instead has steadily promoted reforms on the marketization of the RMB exchange rate.

Currently the RMB’s real effective exchange rate has appreciated by 35 percent compared with that in 2005. China’s current account surplus has fallen from about 10 percent in 2007 to 2.1 percent in 2013, which is below the internationally recognized alarm level of four percent. On its path to balancing its international payments, China has made its own contribution to the development of international trade and the recovery of the world economy.

An employee at the Korea Exchange Bank headquarters in Seoul, South Korea, counts RMB 100 banknotes.

WEN BIN is a Ph.D in economics and a research fellow in macroeconomics at the Institute of International Finance at the Bank of China.