China should accelerate the loosening of capital controls, its central bank said, in a report outlining the path to a freely tradable currency and more open capital markets.
While China’s economy has grown dramatically over the past three decades, its financial markets have remained mostly closed off from the rest of the world. Opening the capital account would give foreigners far more access to Chinese stocks and bonds and help transform the renminbi into a global currency and potential rival to the dollar.
The proposal signals that officials in favor of bolder economic reforms may be trying to seize the initiative just months before a once in a decade leadership transition is announced.
“This seems to be a very clear timetable to push capital account liberalization,” said Liu Ligang, an economist with ANZ. “The resistance [against] faster liberalization is not as strong as before.”
Such reform carries major risks, potentially undermining the government controls on cross-border capital flows that have shielded China from the global financial crisis and could meet opposition from more conservative officials.
The International Monetary Fund and the World Bank have both advised Beijing to relax its tight investment controls. By trapping money in China, the closed capital account has fuelled soaring property prices and generated inflationary pressures.
The World Bank, in partnership with a prominent Beijing think-tank, is due to release its own report next week calling for more ambitious economic reform in China. Wen Jiabao, China’s premier, has repeatedly said liberalization of the capital account is a government priority.
But currency reforms have only advanced at a crawl. Many officials and government advisers remain worried that the Chinese financial system remains fragile and would be undermined by a hasty shake-up.
Sheng Songcheng, the author of the central bank report, was critical of this cautious approach. “By overemphasizing preconditions [to reform], a gradual approach is easily twisted into a negative, immobile approach, leading to delays,” he said. “Being prudent in opening the capital account does not mean waiting for ever.”
The report laid out three stages for reform. The first, over the next three years, would clear the path for more Chinese investment as “the shrinkage of western banks and companies has vacated space for Chinese investments” and presented a “strategic opportunity”. The second phase, in three to five years, would accelerate overseas lending of the renminbi, especially in support of trade deals.
Longer term, over five to 10 years, foreigners would be given more freedom to invest in Chinese stocks, bonds and property. At present, foreign institutions are restricted to relatively small quotas that are subject to a slow approval process.
Free convertibility of the renminbi would be “the last step” to be taken at some unspecified time, the central bank added, with restrictions on “speculative” capital flows and short-term foreign borrowing.