Fewer controls on investment money flows is a key to internationalizing the renminbi

One of the most arduous tasks in China's economic reforms is to phase out its capital account controls as the country has relied on these curbs to manage and regulate its financial market for decades.

But fortunately there are a few signs that China is determined to greatly step up its efforts to loosen foreign exchange controls under the capital account this year. That definitely would help advance financial reforms and further integrate China into the global financial system.

At the same time it is important for the country to enhance its capability and innovate within its capital-account management system to fend off possible impacts from global financial turmoil.

Small steps have been taken in the past few years in opening up China's capital account, which mainly tracks capital flows incurred by investment. However, the progress is slow compared with the opening-up of the current account, which mainly tracks capital flows incurred by trade. In fact, China's current account is almost fully liberalized, but restrictions still remain on capital flows under the capital account.

One of these restrictions is that individuals can move only $50,000 a year across the Chinese border, while corporate cross-border investments need government approval.

Fortunately, deregulation in this regard is likely to happen. According to media reports, the People's Bank of China plans to launch a trial program that will allow individuals in the Shanghai Free Trade Zone to invest in overseas markets directly for the first time. Under the program known as the Qualified Domestic Individual Investor program, or QDII2, the annual purchase ceiling of $50,000 worth of foreign currency is expected to be scrapped. It is also reported that the program is likely to be launched in the first half of this year.

Given China's practice of piloting a policy in a selected region before making it nationwide, things look hopeful that the QDII2 program will eventually become national policy.

Apparently, the QDII2 program will be a significant reform in the promotion of capital account convertibility, showing that consensus has been reached among major policymakers on the importance and urgency of pushing for the liberalization of the capital account, one of the major reform tasks in the financial sector. Previously, the opinion supporting a closed capital account was popular, especially after China's capital account controls helped reduce the impact on China of the 2008-09 global financial crisis. Because of divided opinions, the reform on capital account convertibility made little progress in the past few years.

With the QDII2 ready to be launched, it is clear that top policymakers have made up their minds to keep the ball rolling. Central bank Governor Zhou Xiaochuan has said on several occasions in the past few months that China must pick up speed in opening up its capital account.

China's eagerness is easy to understand, considering the country's national strategy of promoting the internationalization of its currency, the renminbi.

Since 2008, China has made great strides in globalizing the currency, which is used more and more in foreign trade, thanks to an open current account. In the first quarter of this year, cross-border trade settled in renminbi amounted to 1.655 trillion yuan ($267 billion; 244 billion euros), accounting for 27 percent of China's total foreign trade.

However, the renminbi has been used less in cross-border investments since the capital account is still subject to many restrictions. In the first quarter, yuan-denominated cross-border investments, including inbound and outbound direct investments, amounted to only 288 billion yuan, much smaller than the amount of yuan-denominated cross-border trade. To continue promoting the use of yuan globally, it is necessary to open up the capital account to attract more businesspeople, both inside and outside China, to make investments using the yuan.

In addition, opening-up would make the yuan more acceptable in the international financial system. The International Monetary Fund will decide in the fourth quarter of this year whether to include renminbi in the Special Drawing Rights basket, and one of the key criteria is for China to further liberalize its capital account or have a fully convertible currency. To become an SDR family member, the renminbi must be convertible in both current and capital accounts.

Special Drawing Rights are supplementary foreign exchange reserve assets whose value is based on a basket of key international currencies reviewed every five years, according to the IMF. Becoming a SDR currency means a strong international endorsement of the renminbi's status as a foreign exchange reserve currency and will greatly increase foreign countries' willingness in holding the yuan.

Although it is necessary to liberalize capital account management, it is equally important to minimize risks associated with opening-up. To that end, China will need to adopt a strategy of loosening micro-management but stepping up macro-management of the capital account. This means it will place a macro control on capital flows and impose interim restrictions once abnormal money flows pose a threat to financial stability. But on a routine basis, controls on individual deals can be largely removed.

The author is a Shanghai-based financial analyst. The views do not necessarily reflect those of China Daily.

(China Daily European Weekly 05/29/2015 page11)