Financial liberalisation, Chinese-style
Beijing’s line on capital market opening aligned with IMF’s approach
by David Marsh
Mon 23 Jun 2014
For several years, a great dilemma has surrounded China’s drawn-out campaign to open up its financial markets, liberalise capital flows and allow the renminbi to become a much more important trade and investment currency on the world stage. The hoped-for benefits are mighty ones, but so are the challenges. Full liberalisation would make Beijing the servant and not the master of international monetary fluctuations. The way out of this dilemma has now become clearer. China’s planned liberalisation will be heavily constrained by rules and regulations.
Well aware of the downside of losing the capability to steer their own currency, leading Chinese officials say that the traditional ‘administered’ approach to running the renminbi will be replaced by ‘macroprudential management’. In other words, Beijing will remain firmly in control.
Under what the Beijing authorities call ‘the new concept of convertibility', China will engineer a much wider use of the renminbi across the global landscape, while continuing to exercise overall stewardship. The benefit for the Chinese authorities is that ‘liberalisation, Beijing-style’ is completely aligned with new thinking at the International Monetary Fund (IMF), announced in November 2012, which explicitly approved ‘capital flow management measures’ as part of a fresh approach to international monetary coordination.
The reward that beckons for Beijing is substantial: to rival the status of the dollar and, one day perhaps, to displace it as the No. 1 international currency. Such a prize would allow China to carry out a great variety of transactions in goods, services and capital on more advantageous conditions than at present, adding a sizeable dose of economic clout to its sought-after status as a political superpower.
The ultimate goal is to capture part of America’s so-called ‘exorbitant privilege’ stemming from the dollar’s position as the world’s prime reserve asset. This in turn gives the US Treasury, over the longer term, the comfortable ability of being able to fund its deficits via foreign inflows, at much lower rates of interest than most other countries.
Already in the past three years, China has made considerable progress in renminbi internationalisation in terms of increasing the use of the currency for trade flows and in capital raising. Centres like London, Frankfurt and Luxembourg, as well as Hong Kong and Singapore, have now emerged as offshore hubs for renminbi transactions.
Much more is on the way. Beijing will open its onshore capital markets for fundraising by international companies (as opposed to use of Hong Kong, where much international renminbi borrowing has been concentrated so far). More international asset managers are being given quotas for onshore investment in China, while Chinese asset management companies are building plans for expanding their operations abroad.
In contrast to the fraught state of Britain’s overall political relations with the rest of the European Union, London and Frankfurt have developed an informal understanding that the two cities will share the main responsibilities in Europe for boosting cross-border use of the renminbi. Latest announcements that China Construction Bank and Bank of China will be official clearing banks for renminbi trading in London and Frankfurt respectively underline the concerted approach.
The Chinese authorities agree with their counterparts in the UK and Germany that the two cities are complementary in view of their respective importance for the global financial markets, where London has the main prowess, and for the industry-based ‘real economy’ of Europe, where Frankfurt is in the lead.
The problem for China is that financial openness, and above all proceeding to full convertibility of the renminbi by completing the liberalisation of capital account transactions, would make the Beijing authorities vulnerable to the possibility of sizeable amounts of funds leaving the country.
Further, it would expose China far more than at present to the vagaries of US monetary policy and to waves of foreign speculation of the sort that brought down Asian currencies in the continent’s financial crisis of 1997-98. China’s leaders do not forget that one reason for the demise of the Nationalist regime of Chiang Kai-shek, and the eventual birth of the Communist People’s Republic in 1949, was that in the 1940s China lost control of the currency – a mistake that Beijing’s present leaders are determined not to repeat.
Fortunately – and not without considerable persuasive efforts from China and other emerging market economies – the IMF has moved in a direction backing a middle line on capital account opening. According to the IMF’s new policy on capital flows, announced in November 2012, ‘countries with extensive and long-standing measures to limit capital flows are likely to benefit from further liberalisation in an orderly manner. There is, however, no presumption that full liberalisation is an appropriate goal for all countries at all times.’
The absence of full capital account liberalisation does not deter an estimated 30 to 40 central banks from around the world from holding significant quantities of renminbi in their foreign reserves. Chinese banks in London and other overseas centres are formulating plans for new renminbi-denominated instruments – including swaps and options, commercial paper, various arrangements for bond trading and collateral, and different forms of investment products.
All this can take place in an environment where the Beijing authorities retain, as far as possible, overall control. Internationalisation of the renminbi is one of the greatest experiments in economic history – and China is determined to ensure that as little as possible goes wrong.
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