*Research Center for International Finance, Policy Brief
China’s Capital Control: Stylized Facts and Referential Lessons
Zhang Ming
After the fully liberalization of its current account in 1996, China began to liberalize its capital account in a gradual and cautious way. From the capital flow category perspective, the control on direct investment has already been removed, but portfolio investment and short-term debt are still regulated tightly. From the capital flow direction perspective, the intention of Chinese government on capital control is determined by the real direction of capital flow at current stage. For example, during 1990s when China had a limited foreign exchange reserve and faced capital outflow pressure, the government adopted an “easy in, difficult out” strategy. However, during 2000s when China had already accumulated a huge foreign exchange reserve and had been facing dramatic capital inflow, the government turned to an alternative “easy out, difficult in” strategy. The counter-cyclical style of China’s capital control strategy demonstrates the government’s effort to avoid vast capital outflow or inflows.
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Chinese government has been take different treatments to foreign and domestic enterprises in cross-border debt financing. As for debt inflows, foreign enterprises are allowed to borrow freely for many years as long as total foreign liability does not exceed the gap between the registered capital and the investment amount, but qualified domestic enterprises did not get the permission to borrow short-term foreign debt under quotas until early 2010. As for debt outflows, Chinese commercial banks have been authorized to lend overseas since 2008, and qualified domestic enterprises have been approved to lend money to their overseas subsidiaries from 2009.
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Third, China still faces the challenge of sequencing capital account openness and the liberalization of interest rate and exchange rate. Some economists argue that, due to the resistance of interest groups, it is very difficult to complete the liberalization of interest rate and exchange rate in the short-term, therefore Chinese government should speed up the opening of capital account first. Ideally and theoretically, the fast liberalization of capital account will exert external pressure on the government to further liberalize interest rate and exchange rate. However, if the capital account is fully opened before the liberalization of interest rate and exchange rate, there will be a significant interest rate spread between domestic and overseas markets and a strong RMB appreciation expectation, which will no doubt arouse more dramatic short-term capital inflow. The volatile and speculative capital inflow will exacerbate the domestic excess liquidity, thus leading to asset price bubbles and inflation pressure first. If the capital inflow suddenly stops or even reverses in the future, there will probably be a devastating financial crisis. Therefore, the liberalization of interest rate and exchange rate should be a prerequisite for the fully opening of Chinese capital account. Moreover, the liberalization of interest rate and exchange rate could improve resource allocation and promote the transition of growth model. Chinese government should try to overcome the resistance of interest groups, and liberalize interest rate and exchange rate as soon as possible.