A Chinese Trilemma: Renminbi Internationalization, Capital Account Opening, and Domestic financial liberalization By arthur Kroeber Arthur Kroeber is managing director of Gavekal Dragonomics, an economic research firm with offices in Hong Kong and Beijing, and editor of the China economic quarterly Since 2009 Chinese authorities have indicated, in policy actions, research documents and speeches, a general intention to pursue financial sector reform through three main channels internationalization of China's currency, the renminbi; gradual opening of the capital account and liberalization of domestic interest rates yet the reforms in all three areas have been fitful and intermittent, and more important the government has not communicated a clear vision of how these reforms will be sequenced. It is generally recognized that a failure to properly sequence financial reforms can have severe and even disastrous consequences. It is hard to square the apparently high priority given to financial reforms with their apparently incoherent mplementation. I will argue that this contradiction arises not from a flawed strategy but from the efforts of reformers to push ahead financial liberalization in an opportunistic way in the face of strong political opposition and bureaucratic fragmentation RMB internationalization: stalking horse for domestic financial reform? In a developing economy with heavily regulated domestic interest rates, capital controls and a non-convertible currency, a normal sequence of financial liberalization would be to deregulate domestic interest rates first, liberalize the capital account next, and finally (and optionally push ahead the international use of one's currency for trade invoicing and debt issuance. (In earlier eras developing countries were often encouraged to lift capital controls at a relatively early stage but a sequence of emerging-market financial crises in the 1990s, culminating with the Asian Financial Crisis of 1997-98, demonstrated the folly of premature capital-account opening. The IMF, once the strongest institutional advocate of open capital accounts, now accepts the usefulness of capital controls in emerging economies. China, uniquely, reversed this conventional order by launching an ambitious currency internationalization program in 2009 despite maintaining draconian capital controls and heavily regulated domestic interest rates. The RMB internationalization drive mainly involved permitting banks in Hong Kong to offer rMB deposit accounts, encouraging the invoicing and settlement of China's foreign trade in RMB, and creating markets for the issuance of RMB-denominated bonds, initially in Hong Kong and later in other jurisdictions including Singapore and London At around the same time, the People's Bank of China(PBC)signed a number of swap The IMF's new conditional acceptance of the usefulness of capital controls is in Staff Position Note-Capital Inflows: The Role of Controls, SPN/10/04, 19 February, 2010. This reverses a stance from five years earlier deploring their use: International Monetary Fund, Independent Evaluation Office, Report on the Evaluation of the IMF's Approach to Capital Account Liberalization", SM/05/142, Chapter 2, 20 April, 2005
A Chinese Trilemma: Renminbi Internationalization, Capital Account Opening, and Domestic Financial Liberalization By Arthur Kroeber Arthur Kroeber is managing director of Gavekal Dragonomics, an economic research firm with offices in Hong Kong and Beijing, and editor of the China Economic Quarterly. Since 2009 Chinese authorities have indicated, in policy actions, research documents and speeches, a general intention to pursue financial sector reform through three main channels: internationalization of China’s currency, the renminbi; gradual opening of the capital account; and liberalization of domestic interest rates. Yet the reforms in all three areas have been fitful and intermittent, and more important the government has not communicated a clear vision of how these reforms will be sequenced. It is generally recognized that a failure to properly sequence financial reforms can have severe and even disastrous consequences. It is hard to square the apparently high priority given to financial reforms with their apparently incoherent implementation. I will argue that this contradiction arises not from a flawed strategy but from the efforts of reformers to push ahead financial liberalization in an opportunistic way in the face of strong political opposition and bureaucratic fragmentation. RMB internationalization: stalking horse for domestic financial reform? In a developing economy with heavily regulated domestic interest rates, capital controls and a non-convertible currency, a normal sequence of financial liberalization would be to deregulate domestic interest rates first, liberalize the capital account next, and finally (and optionally) push ahead the international use of one’s currency for trade invoicing and debt issuance. (In earlier eras developing countries were often encouraged to lift capital controls at a relatively early stage, but a sequence of emerging-market financial crises in the 1990s, culminating with the Asian Financial Crisis of 1997-98, demonstrated the folly of premature capital-account opening. The IMF, once the strongest institutional advocate of open capital accounts, now accepts the usefulness of capital controls in emerging economies. 1 ) China, uniquely, reversed this conventional order by launching an ambitious currencyinternationalization program in 2009 despite maintaining draconian capital controls and heavily regulated domestic interest rates. The RMB internationalization drive mainly involved permitting banks in Hong Kong to offer RMB deposit accounts, encouraging the invoicing and settlement of China’s foreign trade in RMB, and creating markets for the issuance of RMB-denominated bonds, initially in Hong Kong and later in other jurisdictions including Singapore and London. At around the same time, the People’s Bank of China (PBC) signed a number of swap 1 The IMF’s new conditional acceptance of the usefulness of capital controls is in Staff Position Note – Capital Inflows: The Role of Controls”, SPN/10/04, 19 February, 2010. This reverses a stance from five years earlier deploring their use: International Monetary Fund, Independent Evaluation Office, “Report on the Evaluation of the IMF’s Approach to Capital Account Liberalization”, SM/05/142, Chapter 2, 20 April, 2005
agreements with other central banks, in principle enabling a degree of RMb liquidity in countries other than China. This effort was unprecedented there is no other example of a country deliberately trying to internationalize its currency while maintaining a closed capital account What accounted for this unusual decision? Two observations about the backdrop for the rmB internationalization push help us to understand. First, currency internationalization came in the aftermath of the 2008 global financial crisis. Moreover it commenced shortly after People's Bank of China(PBC)governor Zhou Xiaochuan published a series of essays suggesting that the crisis was caused in part by the US dollar's dual role as a national currency and the main international reserve currency, and suggesting that the role of international reserve currency be taken over by a supra-national unit such as the IMF's special drawing rights. This led many observers to conclude that the goal of Rmb international ization was to set up the Chinese currency as an alternative or rival to the US dollar. The apparent logic was that in the event of a future crisis in which US dollar channels of finance dried up, as they did in the fall of 2008, China's own international trade and investment flows could still continue, supported by RMB finance But this explanation foundered on the contradiction between an internationalized currency and a closed capital account. In the absence of free two-way portfolio capital flows between China and the rest of the world, there was no conceivable way that internationally-available RMB balances could even come close to reaching the levels necessary to make the currency a viable international alternative to the US dollar. So either the pbc didnt know what it was doing, or something else was going on This brings us to the second background observation, which is that in the five years before the late 1990s with the recapitalization of China's technically insolvent Big Four state own the RMB internationalization program, domestic financial reform had bogged down. Starting in banks, there was a period of rapid financial-sector liberalization which included the restructuring and international listing of the big banks, the creation of specialized finance companies, and the aying of plans for interest-rate deregulation. But from 2004, the financial reform efforts fizzled out one by one. After the elimination of the ceiling on bank lending rates in October 2004, interest-rate reform halted entirely, and both deposit and benchmark loan rates were kept at artificially low levels. State-owned banks grew fat on a guaranteed interest rate margin, and paid little attention to their foreign strategic shareholders, who gradually sold off most of their shares See Mc Cauley, Robert N. 2011. "Internationalizing the Renminbi and Chinas Economic Development Model, Council on Foreign Relations Working Paper, November 2011; and Jeffrey Frankel, " Historical Precedents for the Internationalization of the RMB, paper presented at a workshop organized by the Council on Foreign Relations and the China Development Research Foundation, I November 2011 3 See zhou xiaochuan,关于改革国际货币体系的思考(“ Reflections on reforming the international monetar System"), March 23, 2009 (http://www.pbc.govcn/publish/goutongiaoliu/524/2010/20101119161635846466813/2010111916163584646681
agreements with other central banks, in principle enabling a degree of RMB liquidity in countries other than China. This effort was unprecedented: there is no other example of a country deliberately trying to internationalize its currency while maintaining a closed capital account.2 What accounted for this unusual decision? Two observations about the backdrop for the RMB internationalization push help us to understand. First, currency internationalization came in the aftermath of the 2008 global financial crisis. Moreover it commenced shortly after People’s Bank of China (PBC) governor Zhou Xiaochuan published a series of essays suggesting that the crisis was caused in part by the US dollar’s dual role as a national currency and the main international reserve currency, and suggesting that the role of international reserve currency be taken over by a supra-national unit such as the IMF’s special drawing rights.3 This led many observers to conclude that the goal of RMB internationalization was to set up the Chinese currency as an alternative or rival to the US dollar. The apparent logic was that in the event of a future crisis in which US dollar channels of finance dried up, as they did in the fall of 2008, China’s own international trade and investment flows could still continue, supported by RMB finance. But this explanation foundered on the contradiction between an internationalized currency and a closed capital account. In the absence of free two-way portfolio capital flows between China and the rest of the world, there was no conceivable way that internationally-available RMB balances could even come close to reaching the levels necessary to make the currency a viable international alternative to the US dollar. So either the PBC didn’t know what it was doing, or something else was going on. This brings us to the second background observation, which is that in the five years before the RMB internationalization program, domestic financial reform had bogged down. Starting in the late 1990s with the recapitalization of China’s technically insolvent “Big Four” state owned banks, there was a period of rapid financial-sector liberalization which included the restructuring and international listing of the big banks, the creation of specialized finance companies, and the laying of plans for interest-rate deregulation. But from 2004, the financial reform efforts fizzled out one by one. After the elimination of the ceiling on bank lending rates in October 2004, interest-rate reform halted entirely, and both deposit and benchmark loan rates were kept at artificially low levels. State-owned banks grew fat on a guaranteed interest rate margin, and paid little attention to their foreign strategic shareholders, who gradually sold off most of their shares. 2 See McCauley, Robert N. 2011. “Internationalizing the Renminbi and China’s Economic Development Model,” Council on Foreign Relations Working Paper, November 2011; and Jeffrey Frankel, “Historical Precedents for the Internationalization of the RMB,” paper presented at a workshop organized by the Council on Foreign Relations and the China Development Research Foundation, 1 November 2011 3 See Zhou Xiaochuan, 关于改革国际货币体系的思考 (“Reflections on Reforming the International Monetary System”), March 23, 2009 (http://www.pbc.gov.cn/publish/goutongjiaoliu/524/2010/20101119161635846466813/20101119161635846466813 _.html)
Foreign banks' share of total banking system assets remained stagnant at around 2%. After the opening of a commercial-paper market in 2005, efforts to free up the bond markets struggled and while issuance rose, trading volumes remained anemic, making the bond markets useless for the pricing of capital. After the reform of government shareholding in listed companies in 2006 and a short-lived stock market bubble in 2007, Chinas equity markets languished and remained dominated by state-controlled firms. In short, market-oriented financial reform had virtually halted in the face of stiff resistance from existing state-owned financial institutions and a political leadership that had little interest in relaxing the central governments grip on the levers of finance In this context, the RMB internationalization campaign can plausibly be read as a back-door effort to get domestic financial reform going again. The apparent logic was that with the creation of a market-driven RMB interest rate offshore, opportunities would arise for arbitrageurs to profit from the difference between market-driven offshore rates and administered onshore rates The only way to eliminate this arbitrage gap would be to dismantle capital controls, thereby forcing convergence of the offshore and onshore rates. Better yet, the interest-rate gap could be largely eliminated by domestic interest rate liberalization before capital controls were removed So the"premature"internationalization of the RMB, although highly unorthodox and evidently sold to the leadership as a means of freeing China from the hegemony of the Us dollar, was more likely a stratagem by reformers to nudge along the domestic financial liberalization process. In this regard it is interesting to note that the momentum behind RMB internationalization which was dramatic in 2010-11 with large increases in RMB deposits and bond issuance in Hong Kong, and rapid adoption of RMB invoicing by Chinese importers and exporters-slowed notably in 2012. The RMB's share of foreign-currency deposits in Hong Kong rose from 2% in 2009 to a peak of just over 20% by November 2011; it then subsided to a steady level of around 17% in 2012. RMb bond issuance was about the same in 2012 as in 2011. at around Rmb100 bn (although issuance of RMB certificates of deposit rose substantially) Domestic interest rates: deregulation through inaction Yet even as the offshore rMb market cooled, the onshore"shadow finance system was exploding, most obviously through the proliferation of so-called "wealth management products (WMPs). Although they vary in structure, WMPs are in essence a close analogue of the money market mutual funds that arose in the United States in the 1970s as a way of giving savers higher rates of return than offered by bank deposits, whose rates- both in the us in the 1970s and in China today -were subject to regulatory ceilings. The stock of bank-issued WMPs rose from I make this argument in more detail in Chinas Global Currency: Lever for Financial Reform, Brookings Institution,April2013(http://www.brookings.edu/research/papers/2013/04/china-global-currency-financial-
Foreign banks’ share of total banking system assets remained stagnant at around 2%. After the opening of a commercial-paper market in 2005, efforts to free up the bond markets struggled, and while issuance rose, trading volumes remained anemic, making the bond markets useless for the pricing of capital. After the reform of government shareholding in listed companies in 2006 and a short-lived stock market bubble in 2007, China’s equity markets languished and remained dominated by state-controlled firms. In short, market-oriented financial reform had virtually halted in the face of stiff resistance from existing state-owned financial institutions and a political leadership that had little interest in relaxing the central government’s grip on the levers of finance. In this context, the RMB internationalization campaign can plausibly be read as a back-door effort to get domestic financial reform going again. The apparent logic was that with the creation of a market-driven RMB interest rate offshore, opportunities would arise for arbitrageurs to profit from the difference between market-driven offshore rates and administered onshore rates. The only way to eliminate this arbitrage gap would be to dismantle capital controls, thereby forcing convergence of the offshore and onshore rates. Better yet, the interest-rate gap could be largely eliminated by domestic interest rate liberalization before capital controls were removed. So the “premature” internationalization of the RMB, although highly unorthodox and evidently sold to the leadership as a means of freeing China from the hegemony of the US dollar, was more likely a stratagem by reformers to nudge along the domestic financial liberalization process.4 In this regard it is interesting to note that the momentum behind RMB internationalization – which was dramatic in 2010-11 with large increases in RMB deposits and bond issuance in Hong Kong, and rapid adoption of RMB invoicing by Chinese importers and exporters – slowed notably in 2012. The RMB’s share of foreign-currency deposits in Hong Kong rose from 2% in 2009 to a peak of just over 20% by November 2011; it then subsided to a steady level of around 17% in 2012. RMB bond issuance was about the same in 2012 as in 2011, at around Rmb100 bn (although issuance of RMB certificates of deposit rose substantially). Domestic interest rates: deregulation through inaction Yet even as the offshore RMB market cooled, the onshore “shadow finance” system was exploding, most obviously through the proliferation of so-called “wealth management products” (WMPs). Although they vary in structure, WMPs are in essence a close analogue of the money market mutual funds that arose in the United States in the 1970s as a way of giving savers higher rates of return than offered by bank deposits, whose rates – both in the US in the 1970s and in China today – were subject to regulatory ceilings. The stock of bank-issued WMPs rose from 4 I make this argument in more detail in China’s Global Currency: Lever for Financial Reform, Brookings Institution, April 2013 (http://www.brookings.edu/research/papers/2013/04/china-global-currency-financial-reformkroeber)
less than rmb2 trn at the end of 2010 to over rmb7 trn at the end of 2012. with another rmb 1 1.5 trn of WMPs on issue from trust companies, diversified financial services firms not subject to bank regulation. Since late 2012 the weighted average interest rate on three-month WMPs has hovered in the range of 4-5%, or about 150-250 basis points higher than the comparable bank deposit rate. On the other side of the balance sheet, the years 201 1-20 12 saw an impressive increase in"shadow lending, which in the Chinese context refers to a wide range of credit arrangements other than normal bank loans, including loans by trust companies, discounting of commercial bills, and loans from one corporation to other(typically, from a state-owned enterprise to a private company)in which a bank or trust company acts as an intermediary Almost all of the acceleration in total credit growth from mid-2012 through April 2013 came via shadow lending", growth in traditional bank credit remained more or less static during this period Despite much excited commentary in the international financial media, the response by Chinas regulators to the rise of the shadow finance system has been relaxed. PBC governor Zhou and various other officials have generally taken the public view that most of the shadow system, on oth the WMP and the lending side, reflects a healthy response to market demands that the traditional banking sector cannot meet. Periodic efforts have been made to slow the growth of shadow lending bly since May 2013), but in the main regulators have been content to allow the shadow sector 's share of total credit to rise The best way to describe this stance is"deregulation through inaction " Formal deregulation of bank deposit rates, though considered by many analysts to be an urgent and essential reform, is proceeding sluggishly. Banks were granted very modest flexibility to adjust deposit rates above PBC-set benchmarks in June 2012; but since then no additional steps have been taken, and the government has recently backed off from pledges made at the National Peoples Congress in March 2013 to make specific additional moves on deposit-rate deregulation before the end of the year. In the absence of a clear political consensus to move ahead with formal interest-rate beralization, financial reformers appear to have embraced a strategy of growing out of the plan": instead of pushing aggressively deregulation of the regulated financial sector, they will simply allow the more weakly regulated shadow system to grow more rapidly than the regulated secto This approach is deeply unsatisfying to many purists. For one thing, the broader benefits of leposit-rate liberalization(notably the boost to household incomes from the increase on the return on financial assets) are vitiated if higher interest rates are restricted to WMPs, which usually carry a minimum deposit of Rmb50,000 or more and so are available only to the richest Nicholas Borst, "Shadow Deposits as a Source of Financial Instability: Lessons from the American Experience for China, " Peterson Institute for International Economics policy brief, May 2013 Nicholas Lardy, Sustaining China's Growth After the Global Financial Crisis, Peterson Institute for International Economics. 2012
less than Rmb2 trn at the end of 2010 to over Rmb7 trn at the end of 2012, with another Rmb 1- 1.5 trn of WMPs on issue from trust companies, diversified financial services firms not subject to bank regulation. Since late 2012 the weighted average interest rate on three-month WMPs has hovered in the range of 4-5%, or about 150-250 basis points higher than the comparable bank deposit rate.5 On the other side of the balance sheet, the years 2011-2012 saw an impressive increase in “shadow lending,” which in the Chinese context refers to a wide range of credit arrangements other than normal bank loans, including loans by trust companies, discounting of commercial bills, and loans from one corporation to other (typically, from a state-owned enterprise to a private company) in which a bank or trust company acts as an intermediary. Almost all of the acceleration in total credit growth from mid-2012 through April 2013 came via “shadow lending”; growth in traditional bank credit remained more or less static during this period. Despite much excited commentary in the international financial media, the response by China’s regulators to the rise of the shadow finance system has been relaxed. PBC governor Zhou and various other officials have generally taken the public view that most of the shadow system, on both the WMP and the lending side, reflects a healthy response to market demands that the traditional banking sector cannot meet. Periodic efforts have been made to slow the growth of “shadow lending” (notably since May 2013), but in the main regulators have been content to allow the shadow sector’s share of total credit to rise. The best way to describe this stance is “deregulation through inaction.” Formal deregulation of bank deposit rates, though considered by many analysts to be an urgent and essential reform6 , is proceeding sluggishly. Banks were granted very modest flexibility to adjust deposit rates above PBC-set benchmarks in June 2012; but since then no additional steps have been taken, and the government has recently backed off from pledges made at the National People’s Congress in March 2013 to make specific additional moves on deposit-rate deregulation before the end of the year. In the absence of a clear political consensus to move ahead with formal interest-rate liberalization, financial reformers appear to have embraced a strategy of “growing out of the plan”: instead of pushing aggressively deregulation of the regulated financial sector, they will simply allow the more weakly regulated shadow system to grow more rapidly than the regulated sector. This approach is deeply unsatisfying to many purists. For one thing, the broader benefits of deposit-rate liberalization (notably the boost to household incomes from the increase on the return on financial assets) are vitiated if higher interest rates are restricted to WMPs, which usually carry a minimum deposit of Rmb50,000 or more and so are available only to the richest 5 Nicholas Borst, “Shadow Deposits as a Source of Financial Instability: Lessons from the American Experience for China,” Peterson Institute for International Economics policy brief, May 2013. 6 Nicholas Lardy, Sustaining China’s Growth After the Global Financial Crisis, Peterson Institute for International Economics, 2012
Chinese. Another objection is that in the absence of any formal deposit guarantee system, or any credible formal statement by regulators that they absolutely will not make investors in failed WMPs whole, the Chinese system is building up moral hazard that sooner or later is likely to spark a financial crisis These are legitimate concerns. Yet it is also worth asking the question: if, as seems clear, a top- level political consensus for full-scale interest rate liberalization does not yet exist, what should financial reformers do? Should they, as the purists imply, seek to minimize the risks posed by the shadow sector by squelching it, and spend their time instead building the architecture(such as a leposit insurance scheme) for a more perfect financial system, to be implemented on some far- off day when political leaders can be convinced of the merits of financial deregulation? Or should they permit a fragmented but powerful de facto financial liberalization occur through the shadow system? It seems clear that reformers have chosen the latter course, and it is by no means obvious that this is inferior to the purist course Implications for capital account liberalization I will conclude this discussion with a few words about full capital account liberalization, which surely qualifies as the most talked-about yet least acted-upon financial reform in China. The talking is mainly done by foreigners, who at least initially would have the most to gain. Until quite recently Chinese officials had been content to discuss about capital-account opening in the vaguest terms possible, holding it out as an ultimate goal, but without anything that could even China's financial system is still one of the least open in the world. Given this pattern ana gi be called the beginnings of a systematic program. By one of the most commonly used metric generally dismal record of developing countries that opened their capital account while their financial systems were immature, it would seem a safe bet that capital account liberalization is a ery distant prospect Recent events have muddied the waters somewhat. first was the aggressive rmB internationalization program initiated in 2009. Anyone with even minimal knowledge of international financial markets can instantly perceive that full internationalization of the rMB including its use as a reserve currency, cannot possibly occur unless capital controls are abolished. So therefore, if an international RMB is indeed a policy goal, then so must full Brookings Institution, February l1 Prasad and Ye Lei 2012. The Renminbi's Role in the Global Monetary System The Chinn-Ito index, cited in Eswar iNdeed, a well-informed observer of China's financial system, former Hong Kong Monetary Authority chief Joseph Yam, published a widely-cited survey of the subject, in which he suggested Chinas ultimate policy goal should be full convertibility, rather than"free convertibility. Under full(but not free)convertibility, capital transactions o all types would be allowed, but subject to various approval processes which would able the authorities to restrict limit flows that they considered potentially damaging to the real economy. Needless to say, this definition scarcely conforms to what observers from advanced(and particularly from Anglo-Saxon) economies would consider to be full capital account liberalization. See Joseph Yam, "A Safe Approach to Convertibility for the renminbi, http:/josephyam.wordpress.com/2011/04/06/a-safe-approach-to-convertibility-for-the-renminbil
Chinese. Another objection is that in the absence of any formal deposit guarantee system, or any credible formal statement by regulators that they absolutely will not make investors in failed WMPs whole, the Chinese system is building up moral hazard that sooner or later is likely to spark a financial crisis. These are legitimate concerns. Yet it is also worth asking the question: if, as seems clear, a toplevel political consensus for full-scale interest rate liberalization does not yet exist, what should financial reformers do? Should they, as the purists imply, seek to minimize the risks posed by the shadow sector by squelching it, and spend their time instead building the architecture (such as a deposit insurance scheme) for a more perfect financial system, to be implemented on some faroff day when political leaders can be convinced of the merits of financial deregulation? Or should they permit a fragmented but powerful de facto financial liberalization occur through the shadow system? It seems clear that reformers have chosen the latter course, and it is by no means obvious that this is inferior to the purist course. Implications for capital account liberalization I will conclude this discussion with a few words about full capital account liberalization, which surely qualifies as the most talked-about yet least acted-upon financial reform in China. The talking is mainly done by foreigners, who at least initially would have the most to gain. Until quite recently Chinese officials had been content to discuss about capital-account opening in the vaguest terms possible, holding it out as an ultimate goal, but without anything that could even be called the beginnings of a systematic program. By one of the most commonly used metrics, China’s financial system is still one of the least open in the world.7 Given this pattern and the generally dismal record of developing countries that opened their capital account while their financial systems were immature, it would seem a safe bet that capital account liberalization is a very distant prospect.8 Recent events have muddied the waters somewhat. First was the aggressive RMB internationalization program initiated in 2009. Anyone with even minimal knowledge of international financial markets can instantly perceive that full internationalization of the RMB, including its use as a reserve currency, cannot possibly occur unless capital controls are abolished. So therefore, if an international RMB is indeed a policy goal, then so must full 7 The Chinn-Ito index, cited in Eswar Prasad and Ye Lei 2012. The Renminbi’s Role in the Global Monetary System, Brookings Institution, February 2012. 8 Indeed, a well-informed observer of China’s financial system, former Hong Kong Monetary Authority chief Joseph Yam, published a widely-cited survey of the subject, in which he suggested China’s ultimate policy goal should be “full convertibility,” rather than “free convertibility.” Under full (but not free) convertibility, capital transactions of all types would be allowed, but subject to various approval processes which would able the authorities to restrict or limit flows that they considered potentially damaging to the real economy. Needless to say, this definition scarcely conforms to what observers from advanced (and particularly from Anglo-Saxon) economies would consider to be “full capital account liberalization.” See Joseph Yam, “A Safe Approach to Convertibility for the Renminbi,” http://josephyam.wordpress.com/2011/04/06/a-safe-approach-to-convertibility-for-the-renminbi/
vertibility. Speculation tal in March 2013 after the new government suggested that it would unveil, by the end of 2013, a concrete plan for achieving full convertibility It is possible that the grand(but unpublicized) vision of Chinese financial reformers is to deregulate domestic financial markets and make the rmb a fully convertible international currency, with domestic bond markets liquid and reliable enough to enable it to become a major reserve currency. But even if so, it is scarcely plausible that this vision could be realized on a time scale of less than one or two decades. More convincing is the explanation I have suggested here, namely that the rmb internationalization program, which seemed to be a thrust toward capital-account opening, was in fact more a tactic in an opportunistic campaign to liberalize domestic financial markets in the face of opposition or suspicion by the nation's political leadership. On the whole, the coming years are likely to see further spasmodic liberalization of Chinas domestic financial system-more through the growth of the lightly-regulated"shadow sector and gradual incorporation of some of its innovations in the formal banking sector, than through a clear-cut program of deregulating banking activities directly. Progress on opening up the capital account, recent appearances notwithstanding, is likely to be far more modest
convertibility. Speculation over the possibility of swift capital-account liberalization intensified in March 2013 after the new government suggested that it would unveil, by the end of 2013, a concrete plan for achieving full convertibility. It is possible that the grand (but unpublicized) vision of Chinese financial reformers is to deregulate domestic financial markets and make the RMB a fully convertible international currency, with domestic bond markets liquid and reliable enough to enable it to become a major reserve currency. But even if so, it is scarcely plausible that this vision could be realized on a time scale of less than one or two decades. More convincing is the explanation I have suggested here, namely that the RMB internationalization program, which seemed to be a thrust toward capital-account opening, was in fact more a tactic in an opportunistic campaign to liberalize domestic financial markets in the face of opposition or suspicion by the nation’s political leadership. On the whole, the coming years are likely to see further spasmodic liberalization of China’s domestic financial system – more through the growth of the lightly-regulated “shadow” sector and gradual incorporation of some of its innovations in the formal banking sector, than through a clear-cut program of deregulating banking activities directly. Progress on opening up the capital account, recent appearances notwithstanding, is likely to be far more modest