Achieving capital account convertibility in China1

Abstract

China has been delaying the plan of achieving capital account convertibility since the Asian financial crisis, although restrictions on capital flows have been reduced steadily, confirmed by the falling Capital Account Control Index. Current restrictions exist mainly for cross-border portfolio investment, debt financing and outward direct investment (ODI). Effectiveness of these restrictions, however, has been declining over time. While capital controls probably helped support domestic financial stability in the past, their potential costs are rising quickly, evidenced by losing independence of the monetary policy. China already possesses a range of favorable conditions for capital account liberalization, including stable macroeconomic situation, healthy fiscal and financial systems, and strong external accounts. Some of these conditions may be reversed in the coming years. Therefore, China should probably try to achieve basic capital account convertibility within the next three to five years. This requires, among others, establishment of market-based interest rates and exchange rates. The authorities could probably remove restrictions on debt financing and ODI quickly. For the more volatile portfolio investment, they could retain the existing qualified foreign institutional investor and qualified domestic institutional investor schemes, with significantly increased quotas but substantially reduced restrictions during the transition period.