By BOB DAVIS and LINGLING WEI
BEIJING—While Chinese leaders are putting final touches on a plan to allow capital to flow more freely into and out of China, the International Monetary Fund has warned that such changes could lead to a massive exodus of money from the country if not handled properly.
Officials say they are looking to what’s known as capital-account liberalization as a way to give the Chinese more choice in financial investments and to use the market to route investment from abroad to promising projects in China.
Foreign investors have long clamored for greater access to China’s financial markets, in part to benefit from future yuan appreciation. The IMF says financial-sector liberalization, especially for interest rates and currency, is necessary to keep China growing at a healthy clip over the coming decades. But it is wary about whether China is ready for significant capital-account liberalization.
According to IMF calculations, a speedy liberalization of cross-border capital movements could produce over several years net outflows from China equal to as much as 15% of the country’s GDP, roughly $1.35 trillion. Of that sum, the Chinese would send as much as $2.25 trillion overseas, while foreigners would invest $900 billion in China.
“The estimates assume a fairly large ‘Big Bang’ style adjustment,” says Markus Rodlauer, the IMF’s China mission chief. “We wouldn’t advise doing this in one step. We’d advise continuing with a gradual approach.” There is no indication Beijing plans a big-bang approach to liberalization. Though it isn’t yet clear how it will proceed.
Capital flows into and out China are now tightly controlled. The China Securities Regulatory Commission recently roughly doubled the total amount foreigners can invest in Chinese securities under a special program to $150 billion. Chinese individuals, meanwhile, are limited to each taking out $50,000 a year from China, mostly for travel or education. Officials say that among other changes, they are looking at greatly expanding the amount of money Chinese can invest overseas.
People’s Bank of China Gov. Zhou Xiaochuan told a financial forum in Shanghai last month that China will speed up the opening up its capital account, though he noted the process would be flexible enough to reimpose restraints in the event of big speculative capital flows. That statement followed another hint that China is planning big changes.
In May, a paper co-written by a senior researcher at the People’s Bank of China said the central bank aims to make the yuan fully convertible by the end of 2015. And at an April IMF seminar on capital-account liberalization, where the IMF brought in experts from central banks around the world to warn about the difficulties of dealing with capital flows, PBOC officials made clear they nonetheless were moving ahead with liberalizing the capital account, participants said.
Currently, individual Chinese have few options to invest their money, let alone abroad. Bank deposits frequently pay less than the rate of inflation and the boom-and-bust history of the local stock markets has scared away many ordinary Chinese. Instead, the Chinese pour money into real estate, producing property bubbles in many cities.
The IMF analysis said freeing capital flows could relieve pressure on the real estate market and give the Chinese wider investment choices. But it also warned the financial sector must be ready to handle huge surges of hot money. One way to do that is by letting exchange rates rise and fall according to market demand, rather than by trying to guide the movement of the currency as the Chinese central bank currently does. A flexible exchange rate acts as a “shock absorber,” says Mr. Rodlauer. Another way is by reimposing currency controls, as a number of nations have done when under pressure and which the IMF has endorsed as a last resort.
The central bank’s liberalization plans even have produced a backlash among some prominent Chinese economists, who warn that China’s financial system isn’t up to the challenge. “If there are large outflows, that could bring down the Chinese financial system,” argues former PBOC monetary adviser Yu Yongding. “The Chinese financial system isn’t resilient at all.”
He Fan, a senior economist at the Chinese Academy of Social Sciences, says China isn’t prepared for changes in global capital flows, such as a ratcheting back of dollar investments outside the U.S., that could result from the U.S. Federal Reserve backing off its substantial monetary stimulus and eventually letting U.S. interest rates rise. “There are no precedents,” Mr. He said. “You need to close the door and clean your house.”
Recently, China’s State Council, the government’s ruling body, approved a free-trade zone in Shanghai as a testing ground for liberalizing cross-border financial transactions and currency flows. The move followed the establishment late last year of a pilot program in Qianhai, near the border with Hong Kong, which is aimed at offering freer currency movements across the border. Still, detailed rules on exactly how both programs work must be hammered out, and some Chinese officials think what the country needs is a broader plan for financial liberalization. “It’s hard to carry out financial reforms only through those pilot programs,” a senior financial official says. “It has to be planned on a national scale.”
-Grace Zhu contributed to this article
Write to Bob Davis at firstname.lastname@example.org and Lingling Wei at email@example.com