Capital Account Liberalization in China:

Some ConsiderationsVivek Arora and Franziska Ohnsorge,

International Monetary FundFebruary 2014

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Benefits and Risks of Capital Account Liberalization Policy Implications China’s Approach in Context International Experiences: Some Examples Implications of China’s Capital Flow Liberalization for

China and the for the World

Outline

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Rising global capital flows, dominated by FDI

Capital Flows to Emerging Markets(percent of GDP)

Source: WEO and BOPS

Capital Flows to Advanced Countries(percent of GDP)

Policy Implications?

Background

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-4

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1990

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Q3

Portfolio - EquityPortfolio - DebtOther FlowsDirect InvestmentNet

Source: IMF BOPS, WEO.

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1990

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Portfolio - EquityPortfolio - DebtOther FlowsDirect InvestmentNet

Source: IMF BOPS, WEO.

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Benefits and risks

•Efficiency, financial competitiveness, productive investment, consumption smoothing

•“Collateral benefits”

Benefits

•Macroeconomic volatility, vulnerability to crises, larger output losses

•Magnified by financial/institutional gaps

Risks

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

5

Policy Implications•No presumption of full

liberalization for all countries at all times;

•Countries with long-standing restrictions may benefit from more liberalization;

•Follow considered, sequenced “integrated” approach

Policy Implicatio

ns

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

6Source: WEO; WDI; World Bank WGI and staff estimates.

Some preconditions: macroeconomic, financial, institutional

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

1996

1998

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2012

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-0.1Institutional Quality

Government Effectiveness

Regulatory Quality

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0102030405060

External debt,in percent of GDP

02,0004,0006,0008,000

10,00012,00014,000

0100200300400500600700

Per Capita GDP(US$, PPP basis)

Emerging marketsChina

Lines: per capita GDP growth (1995=100, right axis)

1995

1997

1999

2001

2003

2005

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2013

01020304050607080

Export and Imports, in percent of GDP (1995=100)

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Liberalize FDI inflows

Liberalize FDI outflows, other

longer-term flows, and

limited short-term flows

Greater liberalization

Revise financial legal framework

Improve accounting and statistics

Strengthen systemic liquidity arrangements and related monetary and exchange operations

Develop capital markets, including pension funds

Cap

ital F

low

Li

bera

lizat

ion

Supp

ortin

g R

efor

ms

Strengthen prudential regulation and supervision, and risk management

Restructure financial and corporate sectors

Greater Liberalization

Integrated Approach to Capital Flow Liberalization

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

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China’s sequence of measuresYear Measure

2001 Resident corporates list overseas; resident individuals buy B-shares2002 QFII scheme (nonresident portfolio investment in China)2004 Approved corporates lend abroad; emigrants transfer limited assets abroad2005 Nonresidents issue RMB bonds in China (Panda bonds)2006 QDII scheme (resident portfolio investment abroad); eliminate approval and

expand financing sources for ODI2007 Expand QDII institutions; raise QDII quota; residents issue RMB bonds offshore2009 RMB use for trade and FDI settlement2010 Approved central banks/foreign bank invest in Chinese bond market; resident

corporates borrow abroad2011 R-FDI scheme (settle FDI in RMB); R-QFII scheme (portfolio investment by

approved corporates with subsidiaries in Hong Kong)2012 QFII quota increased to $80 billion; R-QFII quota increased to RMB200 billion;

quotas on central banks/SWF removed2013 R-QFII: Eligible institutions expanded; restrictions on asset allocation eased

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

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“Accelerate capital account liberalization”

Acceleration of overseas RMB lending

Greater scope for foreigners to invest in RMB assets, and property

Final step: free convertibility of RMB when ready

(February 2012 Report)

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

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International experience: lessonsIsrael 1987-2005 (Flug, 2013)• Synchronized macro stabilization program • Sequencing: foreign residents new immigrants asset managers

corporates households• Closely monitored: approval converted to reporting requirements

Chile from 2000 (Carrière-Swallow and García-Silva, 2013)• Synchronized move to exchange rate flexibility and inflation targeting• Sequencing: pension funds outflows first

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

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Global implications of capital account liberalization in China: Capital Flows

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

Bayoumi and Ohnsorge (2013); He et al. (2012): Capital account opening in China will likely be followed

by substantial increase in gross portfolio flows. Net outflows as domestic investors diversify savings. Net portfolio outflows could dampen reserve

accumulation.

Benelli (2011): $500 billion increase in China’s private foreign portfolio

asset holdings in EMs and decrease in China’s official reserve assets in US instruments would increase US bond yields by 60 bps and reduce EM bond yields by 240 bps.

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Implications of capital account liberalization in China

Benefits and risks Policy implications China’s approach International

experienceGlobal

implications

Global Financial Stability: • Offshore RMB markets (Craig et al., 2013; Hooley, 2013)• Vulnerability to shocks from China (Hooley, 2013)Financial Stability in China: • Reduced liquidity in alternative asset markets (local bond and equity

markets, real estate markets, wealth management products)• Withdrawals of household savings deposits rising deposit rates

reduced bank profitability (Lardy and Douglass, 2011)

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IMF institutional view: no presumption of full liberalization for all countries at all times. But many countries with long-standing restrictions would benefit.

China’s moves are in right direction.

Implications for other countries through portfolio shifts.

Carefully planned and implemented liberalization in China is in the interests of both China and the world.

Conclusions

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Thank you

谢谢 !