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研究组
China’s Capital Account Liberalization:
A ruby jubilee & beyond
Yanliang Miao & Tuo Deng
August 2018
Outline of Chapter
Three debates that shaped China’s capital account liberalization
Lessons learned: the good, the bad, and the “ugly”
China’s capital account policy, through the lens of the three debates
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Three Debates
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1. How open is China’s capital account? What remains to be done?
De jure openness: mixed
Chinn-Ito: unchanged since 1993!
Quinn: improving, but trails average EME
De facto openness: substantially improved, but not complete
IIP: fast growing
Capital account: increasingly volatile
Long-term bond yields: co-moving
Incompleteness: portfolio flows remain scheme-based
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-1.6
-1.2
-0.8
-0.4
0
1984
1986
1988
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
Chinn-Ito Quinn (RHS)
De jure openness: Chinn-Ito vs. Quinn
Source: Chinn & Ito, IMF AREAER.
De facto openness: China’s IIP (Tln. $)
Source: IMF.
-6
-4
-2
0
2
4
6
8
-6
-4
-2
0
2
4
6
8
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
Assets Liabilities Net Position
China’s IIP
China's International Investment Position (Bil. $)
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
Net Position 1494 1491 1688 1688 1867 1996 1603 1673 1950 1814
Assets 2957 3437 4119 4735 5213 5986 6438 6156 6507 6926
FDI 186 246 317 425 532 660 883 1096 1357 1473
Portfolio 253 243 257 204 241 259 263 261 367 497
Equity 21 55 63 86 130 153 161 162 215 308
Debt 231 188 194 118 111 105 101 99 152 190
Other
Investment552 495 630 850 1053 1187 1394 1389 1680 1714
Reserve Assets 1966 2453 2914 3256 3388 3880 3899 3406 3098 3236
FX Reserves 1946 2399 2847 3181 3312 3821 3843 3330 3011 3140
Liabilities 1463 1946 2431 3046 3347 3990 4836 4483 4557 5112
FDI 916 1315 1570 1907 2068 2331 2599 2696 2755 2901
Portfolio 168 190 224 249 336 387 796 817 811 1044
Equity 151 175 206 211 262 298 651 597 580 717
Debt 17 15 18 37 74 89 145 220 232 327
Other
Investment380 442 637 891 943 1272 1440 964 984 1163
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De facto openness cont’d
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Composition of net capital flows (Bil. $)
Source: SAFE.
0.00
1.00
2.00
3.00
4.00
5.00
0.00
1.00
2.00
3.00
4.00
5.00
201111
201205
201211
201305
201311
201405
201411
201505
201511
201605
201611
201705
201711
201805
China US
Source: Chinabond, Federal Reserve Board.
10-year bond yields: China vs. US
-800
-600
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-200
0
200
400
-800
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-400
-200
0
200
400
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
FDI Portfolio Others KA (incl. E&O)
What remains to be done?
IMF’s AREAER
Glass-half-empty: 80% types of capital transactions are subject to some control (Schipke 2017)
Least restricted transactions: FDI, ODI
Glass-half-full: 90% types are at least partially convertible (PBOC 2017)
3 types of unconvertible transactions: foreigners’ equity & money market issuance in domestic markets, derivative transactions
Portfolio investment: low foreign penetration
Foreigners hold 0.4% of China’s credit bonds, and 2% of A-shares
Individual investors: limited ways of investing abroad
Available: QDII funds and Stock Connects
QDII2: under study since 2013, almost launched in 2015
Overseas insurance and home purchases still restricted
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2012 2016
Unconvertible 6 3
Partially convertible 19 20
Mostly convertible 8 9
Convertible 7 8
Source: Jingshan Report (2017), Chapter 5.
China’s capital account convertibility
according to IMF’s AREAER classifications
2. How committed is China to opening its capital account?
Official: vocal commitments
Skepticisms:
Deliberate slowdown, to resist inflows and keep RMB undervalued (Jeanne, Subramanian & Williamson 2011)
Tightening of controls in 2015-2016 reflects lack of commitment (Wharton 2016)
Fear of a massive capital flight and its stress on financial system (Yu 2017)
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3. Is China ready to liberalize its capital account further, and how?
Cautions:
Many preconditions have not been met (Lardy & Douglass 2011, Yu 2015)
External environment is not friendly (Zhang 2015)
Possible side effects (Zhang 2015)
Optimism:
China’s financial system is becoming more robust (Sheng, Xu, Yan & Zhu 2012)
Subtle changes in policymakers’ view:
Early 2010s: optimistic
PBOC’s proposition of studying of QDII2 in 2013
3rd Plenary Meeting of the 18th CPC Central Committee: accelerating capital account convertibility
2015-2016: cautious, focusing on risk
Since 2017: cautiously optimistic
Pan (2017): “The pace of capital account liberalization should be consistent with a country’s economic development, financial market and financial stability, and external conditions.”
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Lessons Learned
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The good: pick the right sequence, and proceed gradually
Open up to FDI flows first
Long-term, stable, low financial risk
Brings in technological & managerial know-how
Gradualism
FDI: pilot programs in the 1980s before fully embracing it
Portfolio: gradually raise the quotas of Q schemes, then introduce C schemes (no individual quotas)
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0
10
20
30
40
50
-10
0
10
20
30
40
50
FDI Portfolio Others
Source: SAFE.
Capital inflows by type, 1982-2000 (Bil. $)
0
100
200
300
400
500
600
700
0
20
40
60
80
100
120
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
QFII (Bil.$) QDII (Bil.$)
RQFII (Bil.CNY, RHS)
Source: SAFE.
Approved quotas of “Q” schemes
The bad: unevenly paced capital flow management reform
Capital flow management reform has undergone a philosophical change since 2009
Ex ante review & approval ex post monitoring & analysis
Positive list negative list
Why skepticism remains?
Reform focuses on micro-level management
Macroprudential framework has been slow to develop and implement
Result: continued reliance on administrative tools and discretion
2015-2016: tightening of de facto outflow controls (without changing the rules)
Market impression: still discriminative, time-inconsistent, and opaque
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The “ugly”: distorted financial system & inflexible exchange rate
2008-2013: sharp carry trade inflows
Financial misallocation at home: high marginal rate for private borrowers, hence large home-abroad interest gap (Song, Storesletten & Zilibotti 2011)
Overseas borrowing relaxed: sharp carry trade inflows
Amplification by inflexible exchange rate
2014-2016: carry trade unwinding
RMB became overvalued
Forced deleveraging of overseas debt by domestic enterprises
Sharp other investment and E&O outflows
13Source: SAFE.
Capital account balance by type (Bil. $)
-800
-600
-400
-200
0
200
400
-800
-600
-400
-200
0
200
400
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
FDI Portfolio Others KA (incl. E&O)
The great capital reversal
The Great Capital Reversal (Bil. $)
2008 2009 2010 2011 2012 2013 2014 2015 2016 2017
1. Current Account 421 243 238 136 215 148 236 304 202 165
(in % GDP) 9.1% 4.8% 3.9% 1.8% 2.5% 1.5% 2.3% 2.8% 1.8% 1.3%
2. Capital Account 40 198 287 265 -32 346 -51 -434 -416 149
(in % GDP) 0.9% 3.9% 4.7% 3.5% -0.4% 3.6% -0.5% -4.0% -3.7% 1.2%
3. Net Errors and
Omission 19 -41 -53 -14 -87 -63 -67 -213 -229 -222
Δ Reserve Assets
(1+2+3) 480 400 472 388 97 431 118 -343 -444 92
FX Reserves 1946 2399 2847 3181 3312 3821 3843 3330 3011 3140
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Overseas borrowing by Chinese corporates
As the interest differential widened from 2008-2014, overseas borrowing by Chinese corporates totaled $1.1 trillion
Since 2015, interest differential narrowed, causing the sharp external deleveraging
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Bonded debt Loans 3m Shibor-Libor (%, RHS)
Capital account balance by type (Bil. $)
Source: Miao & Rao (2016).
The August 11, 2015 exchange rate reform
It was in fact long overdue
Greater exchange rate flexibility: could have dampened carry trade inflows ex ante, or reduce the loss of FX reserves by letting RMB fall
In practice, China relied on FX reserves to counterbalance outflows
A dangerous vicious cycle kicked in, costing $1 trillion in 18 months
Asymmetry: FX reserves can go up without limit, but are bounded from below at 0, at which the central bank is powerless in maintaining exchange rate
Market view FX reserves as the barometer of China’s financial strength (Miao 2018)
FX reserves fall market worry more FX reserves fall even further …
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2018
FX Reserves (Bil.$) USDCNY exchange rate (RHS)
Source: SAFE.
China’s FX reserves and USDCNY exchange rate
China’s Capital Account Policy: Recent Developments
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Opening up further: direct & collateral benefits
Direct benefit: capital account liberalization as an end in itself
Open capital account offers better benefit-risk tradeoff for DMs than for EMs
“Threshold” effect: opening-up may be increasingly favorable for China over time (Kose, Prasad & Taylor 2009, Wei 2018)
“Collateral” benefits: to other key reforms (Kose, Prasad, Rogoff & Wei 2009)
“Ratchet effect”: commitment device for domestic financial reforms (Zhou 2017)
Accommodate RMB’s internationalization
RMB’s inclusion in the SDR basket in 2015: China’s capital account opening-up has passed the point of no return (Zhou 2017)
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Upgrading capital flow management: the dual pillars (Pan 2018)
Microprudential regulation: even-handed & time-consistent
Focus: authenticity & legality of individual transactions
Equal & time-consistent treatments, regardless of type, direction, and timing
Macroprudential regulation: targeted & countercyclical
Focus: overall financial stability
Targeting flows with the most threat: short-term, lending-related flows
Pre-emptive enforcement during inflow booms
Macroprudential regulation complements FX reserves in capital account stabilization
Before exchange rate becomes sufficiently flexible, macroprudential regulation is even more important
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Coordinating the reforms: a troika approach (Zhou 2017, Yi 2018)
In theory: many views
The preconditions view
The sequencing view
The stability view
In practice, the “troika” approach
Idea: pushing the backmarker forward to catch up others, so that all reforms gradually march ahead
Coordinating
Domestic financial reform: interest rate liberalization and beyond
Capital account liberalization
Exchange rate flexibility
Political economy
Helps to resolve bureaucratic deadlocks
Avoids rollbacks
The built-in gradualism and opportunism
No preset schedules
Proceed faster under more favorable conditions
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Adding up: China’s path on the Impossible Trinity
China’s path: B(1994) X(2005) Y(2015) O(2018)
From O A: many possible paths
More aggressive: (c)
More conservative: (b) or (a)
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China’s path on the Impossible Trinity
Source: Miao & Tan (2018).
Alternative paths towards A
Source: Miao & Tan (2018).
Conclusion
Substantial capital account liberalization in the past four decades
Incomplete efforts: portfolio flows still somewhat restricted
Good, bad & ugly lessons
Going forward: committed to financial opening-up, with three principles (Yi 2018)
Pre-establishment national treatment + negative lists for foreign institutions
Coordinating capital account opening-up with financial and exchange rate reforms
Matching the degree of opening-up with regulatory capabilities
The goal: a near-fully convertible capital account + flexible exchange rate + monetary autonomy
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Thank you!
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