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A Study on Gradualness of RMB’s Capital Account Liberalization

Author: MaChengFang
Tutor: YangHuiZuo
School: Jilin University
Course: Western Economics
Keywords: RMB Captial Account Liberalization Gradualness
CLC: F832.6
Type: PhD thesis
Year: 2013
Downloads: 929
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Abstract

The issue about the choice that is made among the gradualliberalization of capital account, an accelerated realization of freeliberalization and an immediate full liberalization has been intensifiedamong Chinese financial theorists and has aroused a wide concern in thepolitical and economic community both at home and abroad. SomeChinese experts and scholars, by comparing the conditions or majoreconomic indicators of China and the countries which have achieved thefree liberalization of capital account, proposed that China shouldaccelerate the process of the liberalization of capital account or therealization of full liberalization.The thesis analyzes the characteristics of capital and capital account according to the basic principles about capital flows of Marx and someother classic writers. Guided by the policy of our Party and thegovernment regarding capital account, from the status and the role ofcapital account, from the special national conditions in China and itsrelations with the United States and other developed countries, combinedwith the course of the liberalization of capital account in China, the paperdiscusses the inevitability of the progressive realization of theliberalization of capital account and comments on the views aboutaccelerating this process. Then it points out that limited control on capitalaccount transactions in China is an effective means to ensure the stabledevelopment of the economy and prevent the financial crisis in ourcountry.According to the actual macroeconomic environment, the situationof the financial system, the market-oriented reform of interest rates, theexchange rate formation mechanism and the microscopic main body ofeconomic operation in China, the thesis demonstrates that promoting the liberalization of capital account in such a fast manner will inevitably leadto large flows of capital in a short term, then will have a tremendousimpact, by affecting the amount of basic currency, on Chinesecommodity price, interest rate and exchange rate, even the independenceand effectiveness of its monetary policy. Therefore, only a progressiverealization of the liberalization of capital account can maintain thestability of monetary policy in China, and then stabilize commodity price,interest rates and exchange ratesThis paper argues that although the full liberalization of capitalaccount can bring the sustained economic growth according to theanalytic framework of new classic growth model, it’s only applicable tothe theory in economically developed countries and the countries whichmaintain close relations with the United States, and it may not beapplicable in China. The practice of China’s30years of reform andopening-up has proved that the management policies adopted on capitalaccount optimized China’s economic structure, accelerated its capital formation, changed its trade structure, promoted its export, thus ensuredthe continuing surplus of balance of payments in China, continuallyincreased its foreign exchange reserves and contributed to the peacefulrise of Chinese economy in the world.This thesis argues that the gradual liberalization of capital accountand the internationalization of RMB are complementary, rather thanindependent of each other. The process of gradual liberalization of capitalaccount can ensure the stability of the internationalization of RMB whichwill create conditions for the former. It’s only with the steady increase ofimport and export trade volume, foreign exchange reserves and capitalinflows and outflows that foreign demand for RMB can continue toincrease and RMB can be gradually internationalized.The paper is composed by seven chapters. The first chapter isintroduction: this part introduces the background and significance of thearticle, theory development, research methods and so on. Althoughcapital account liberalization is not a new research field and lots of theories are created with research development, the lessons fromfinancial crises tell us that capital account liberalization must be agradual process, however, advance the liberalization process blindly andimpractically expose countries to face international capital-flow shocksdirectly; once economic has problems, crises will not be inevitable.Chapter2is the core of this article. This chapter analyzed the capitalprofitability, liquidity, sensitivity and speculative; and these features ofcapital determines the process of improving capital account liberalization;the state should use capital initiatively and exploit positive effects ofcapital flows to avoid its adverse effects. Capital account liberalizationnot only maintains the initiative, but also adheres to gradualness; from ahistorical point of view, the experience of China’s capital accountliberalization is progressive; in reality, the formation of China’s foreignexchange reserves is a condensation of the hard work of Chinese people,the international performance of our value; too fast liberalization processwill lead to rampant speculation inevitably, and then sacrifices foreign exchange reserves. Conditions of Chins in terms of the level of economicdevelopment, the financial system, the level of foreign reserves, interestrate and exchange rate formation mechanism are relatively maturethrough comparing with the situations of other countries who haveachieved capital account liberalization. Compared with these countries,achieving capital account liberalization, there are many differences onour country’s economic system, the legal concept of the people, and thelevel of society development; accelerate the pace of liberalization of thecapital account blindly will inevitably lead to massive capital flight,swept away banks assets and foreign exchange reserves. Therefore, wecannot copy the experience of other countries about capital accountliberalization and cannot be optimistic blindly; our country must explorethe Chinese-style process of gradualness of RMB’s capital accountliberalization.Chapter3analyzes the current situation of China’s capital accountliberalization from the targets of investment projects that include direct investment projects, the securities investment projects and loan projectsand researches the degree of RMB liberalization quantitatively. To directinvestment, China attracts foreign direct investment mostly during theseyears, and foreign direct investment is also rapidly rising year after year;the degree of currency liberalization has reached or exceeded the level ofsome OECD countries. To securities investment, with the launch anddevelopment of QFII, QDII and RQFII, the degree of liberalization ispromoted and cross-border securities investment become more active.Convertible foreign loan, personal loan of capital transactions and otherinvestment projects are improved significantly, but the overall level isrelatively cautious. In this paper, the writer uses the adjusted financialopening index to analyze the degree of liberalization of RMB capitalproject quantitatively and compared the degrees with developed countries,developing countries and countries in transition. Through quantitativeanalysis, conclusion is as follow: the level of capital accountliberalization of RMB is not very high, although the degree of direct investment in our country has reached a considerable level, however, thedegree of the securities and other investment liberalization is still quitelimited.Chapter4analyzes that how the gradualness of capital projectsliberalization influences the objective of monetary policy. Tomacroeconomic performance, the most direct impact from capital flowthat influenced by capital account liberalization is amount of currency incirculation. Now matter, how the currency in circulation change, capitalflow influenced by capital account liberalization will break the originalinternal price system (including the price, interest rate and exchange rate),these indicators are important regulatory targets of monetary policy.Despite the combination of the Impossible Trinity in open economywould evolve as “the capital flows+exchange rate+some independentmonetary policy ", monetary policy will not completely lose itsindependence and effectiveness. While, accompanied with theimprovement of the degree of capital account liberalization, if the adjustment space of exchange rate cannot be expanded, the independenceand effectiveness of monetary policy must reduce gradually andconveniently. As the price of the credit markets, interest rates will also beimpacted by capital account liberalization; because capital has the featureof profitability, once the domestic and foreign interest rates are different,capital arbitrage will exist with international transnational flow, then thechange of fund supply and demand will cause interest rate policy fails.Exchange rate stability as one of the elements of the Impossible Trinitywill also be affected directly by capital flows; once the capital accountliberalization is achieved, if country wants to maintain a fixed exchangerate, country must sacrifice the independence of monetary policy, and ifthere is no sufficient foreign exchange reserves, currency crisis will notbe avoided. To some extent, although the floating exchange rate systemensure the effectiveness and independence of monetary policy and slowdown the flow of speculative capital, frequent adjustment of exchangerate will bring uncertain risks to one country’s economy. Therefore, the mercerization of interest rate and exchange rate formation mechanismreform must be brought forward the process of capital accountliberalization.Chapter5makes an analysis of the role of liberalization of capitalaccount in economic growth. Although the liberalization of capitalaccount can bring such great benefits in aspects of capital accumulation,resource allocation, technology import and innovation capability thatmaintain the sustained economic growth according to the analyticframework of new classic growth model, the strong supportive evidenceis difficult to find in practice. The above-mentioned makes peopleconsider about the relations between liberalization of capital account andeconomic growth from other perspectives, which is with what kind ofconditions and methods can liberalization of capital account promoteeconomic growth and avoid the risks caused by liberalization of capitalaccount to the maximum extent (threshold effect). Therefore, inanalyzing the conditions of liberalization of capital account, China should choose to implement the long-term liberalization of capital account, andadopt a more cautious attitude towards items such as securitiesinvestment in order to promote economic growth and avoid the crisis. Itis also the verification of structural effects hypothesis, in the long-termperspective, foreign direct investment is positive to the economic growthof capital inflow country in a stable manner, however, the capital flow ofnon-direct investment such as foreign securities investment and foreignborrowing is considered as doing more harm than good in general, due tothe easy reversing of capital flow that imperils financial stability incapital inflow country. It is seen through empirical analysis that foreigndirect investment in China vigorously promotes the capital formation andadjustment of economic structure, and enhances the expansion of exportscale and technological progress.Chapter6discusses the relations between the gradual liberalizationof capital account and the internationalization of RMB. Theinternationalization of RMB is not only beneficial for the reform of international monetary system, but also brings China the immediateinterest such as seigniorage revenues and the improvement of terms oftrade. In addition, it is beneficial for enhancing the international standingand influence of China. The liberalization of capital account is anecessary technical prerequisite of RMB internationalization. Although atpresent the full liberalization of capital account has not been realized inChina, yet the internationalization of RMB does not start until the fullliberalization of capital account can be realized. The gradualliberalization of capital account can guarantee the smoothinternationalization process of RMB, while the internationalization ofRMB can create conditions for the liberalization of capital account.According to the principles including inflow first and outflowfollowing, direct investment first and securities investment following,long-term investment first and short-term investment following,institutions first and individual following, financial claim instrumentsfirst and equity instruments and financial derivatives following, issuing market first and trading market following, and trade with real backgroundopens first and trade without real background opens following, the finalpart of the thesis makes the analysis of the future policy regarding thegradual liberalization of capital account in China from the perspectives ofdirect investment, securities investment and foreign lending andborrowing.

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CLC: > Economic > Fiscal, monetary > Finance, banking > China's financial,banking > Exchange rate,foreign financial relations
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