Whether China Should Accelerate Capital Account ...

Whether China Should Accelerate Capital Account ...

Why China should Still be Cautious i n Capital Account Liberalization? Ming Zhang Institute of World Economics and Politics Chinese Academy of Social Science August 2015 Beijing [email protected] 1 Outline The current capital outflow in China; Why China should still be cautious in capital acc ount liberalization? Domestic perspective; International perspective; Combining domestic and international perspectives; New evidence and new trends arguing for capital flo w management;

Policy suggestions. 2 Billion USD The evolution of Chinas twin surpluses 450 400 350 300 250 200 150 100 50 0 -50 Current Account

Capital and Financial Account 3 China has been facing persistent capital outfl ow in the past 5 quarters 150 100 Billion USD 50 0 -50 -100 Current Account Capital and Financial Account 4

The current capital outflow has been driven b y other investment outflow 150 100 Billion USD 50 0 -50 -100 -150 Direct investment Financial Derivatives Portfolio investment Other investment 5

Both residents and non-residents played significant role s in the current other investment outflows 100 50 Billion USD 0 -50 -100 -150 Other investment: Assets Other investment: liabilities 6 Billion USD The current capital outflow is closely related to t

he change of RMB exchange rate expectations 60 50 40 30 20 10 0 -10 -20 -30 85% 80% 75% 70% 65% 60% 55% 50%

Cross-border net income through banks The ratio of forex sales to banks to cross-border gross income through banks 7 6.0000 40913 -2052yyyy/m/d 40962 -2052yyyy/m/d 41009 -2052yyyy/m/d 41053 -2052yyyy/m/d 41096 -2052yyyy/m/d 41138 -2052yyyy/m/d 41180 -2052yyyy/m/d 41229 -2052yyyy/m/d 41271 -2052yyyy/m/d 41325 -2052yyyy/m/d 41367 -2052yyyy/m/d 41416 -2052yyyy/m/d 41463 -2052yyyy/m/d

41505 -2052yyyy/m/d 41556 -2052yyyy/m/d 41598 -2052yyyy/m/d 41641 -2052yyyy/m/d 41690 -2052yyyy/m/d 41732 -2052yyyy/m/d 41779 -2052yyyy/m/d 41822 -2052yyyy/m/d 41864 -2052yyyy/m/d 41907 -2052yyyy/m/d 41956 -2052yyyy/m/d 41998 -2052yyyy/m/d 42044 -2052yyyy/m/d 42093 -2052yyyy/m/d 42137 -2052yyyy/m/d 42180 -2052yyyy/m/d 42222 -2052yyyy/m/d RMB began to face depreciation pressure aga inst USD since 2014Q2

6.4000 6.3000 6.2000 6.1000 RMB/USD: middle price RMB/USD: closing price 8 The reason is the effective exchange rate of RMB appreciate too fast since 2014 140 130 120 110 100 90

80 REER of RMB NEER of RMB 9 Why China should still be cautious in capital a ccount liberalization? (1) Domestic perspective: The declining of Chinas economic growth and the loosening of Chinas m onetary policy; The deleveraging of corporate sector, the downward adjustment of prope rty market, and the burgeoning of local government debts; The negative impact to commercial bank sector from RMB interest rate li beralization; The reverse of RMB exchange rate appreciation expectation; The slowdown of labor productivity growth due to structural adjustment; The shallow and immature financial market under non-unified and ill-coo rdinated regulation regime;

Case: the current boom and crash of stock market; Unsettled uncertainties in both economic and non-economic issues. 10 Why China should still be cautious in capital a ccount liberalization? (2) International perspectives: The recovery of US economy and the relating normaliz ation of US monetary policy; The rise of risk aversion of international investors; The capital outflow pressure faced by emerging marke ts; The threat of persistent stagnation, international trad e contraction and currency war; The Euro zone sovereign debt crisis has not ended wit hout a major debt-restructuring; 11 Why China should still be cautious in capital a

ccount liberalization? (3) Combining domestic and international perspectives: If Chinese government accelerate capital account liberalization, there mi ght be a persistent and large scale capital outflow; The capital outflow and RMB depreciation expectation may reinforce eac h other; The capital outflow might impair domestic financial stability, e.g. accelera ting the corporate sector deleveraging and property market adjustment; PBC might face a new dilemma: If it does not regulate capital outflow, the re might be a systemic financial crisis; If it began to re-regulate capital ou tflow, its reputation might be impaired. So why PBC is so hasty to liberalize the capital account? RMB internationalization? Speed up domestic reforms? 12 Why China should still be cautious in capital a ccount liberalization? (4) New arguments for capital flow management:

Large short-term capital inflow has negative externality, therefore capital flo w management might be desirable; There is no significant evidence between free capital flow and economic gr owth; Capital flow management should be a permanent, not a temporary macro-t ool; Under some circumstances, quantity-based measures are much more effec tive than price-based measures; Re-introducing capital flow management would result in significant adjustm ent costs; After the global financial crisis, both IMF and some emerging market countries changed their attitudes toward capital flow management. 13 Policy suggestions Chinese government should put domestic structural adjustments on the top of its policy agenda. If real economy reform lags too much behind financial reform, there mig ht be some risks;

Chinese government should speed up RMB exchange rate and int erest rate reform, and try to mitigate the negative impacts of the above reform at the same time; Chinese government should strengthen the macro and micro-pru dential management regimes; Chinese government should push forward capital account liberaliz ation still in a gradual , controllable and cautious way; Chinese government should be prepared for the burst of financial crisis. 14

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