22 September 2018
Shanghai's free trade zone is expected to be a test bed for renminbi convertibility. Photo: Bloomberg
Shanghai's free trade zone is expected to be a test bed for renminbi convertibility. Photo: Bloomberg

CPC PLENUM: If not now then when for RMB convertibility?

The gathering will be in Beijing but all eyes will be on Shanghai and the future of its free trade zone when the leaders of China’s ruling party assemble for a four-day direction-setting meeting from Saturday.

The zone is set to be a test bed for China’s experiments to open its capital account and therefore be a proving ground for efforts to achieve full renminbi convertibility. But determining how quickly this opening takes place will be one of the toughest decisions the country’s leaders will have to confront over the next two years, some observers say. 

The lack of consensus on the issue highlights its complexity. When central bank chief Zhou Xiaochuan {周小川}, together with some top economists, suggested in May that the capital account should be opened by 2015, various academics responded with strong opposition. The 21st Century Business Herald’s May 21 report containing Zhou’s proposal was also pulled from the paper’s within hours, triggering speculation that the matter had stirred uproar in the party.

The opponents said the 2013 timetable could result in large-scale capital outflows if the United States raises interest rates over the next two years

“We have for a long time opposed the idea of opening the country’s capital account at a fast pace,” Zhang Ming {張明}, head of the international investment department at the Chinese Academy of Social Sciences’ Institute of World Economics and Politics, said.

Zhang said that in the last few years, China has battled a serious inflationary problem due to the capital inflow brought on by excessive global liquidity. 

“If China rushes to open its capital account by 2015, it will be exposed to a risk of having a large-scale capital outflow,” he said. A flood of foreign and domestic capital rushing out the country will cause a spike in interest rates and renminbi depreciation, which will hurt China’s economic growth.

“Why do we need a timetable for the opening of the capital account? Success will come when conditions are ripe,” he said, adding that China should focus on creating a market-driven interest and exchange rate mechanism and open its financial sector to private investors.

Nonetheless, some academics are tipping that the central bank will open the capital account in the next 18 to 36 months through a trial program in the Shanghai free trade zone. 

“It is possible for China to open its capital account by 2015,” Peking University economics professor Cao Heping {曹和平} told the Hong Kong Economic Journal’s EJ Insight. “There is no reason that capital will flow out of China when the country will continue to create a high return for global investors over the next decade.”

Even if there is capital outflow, China’s 3.6 trillion yuan (US$590.4 billion) in foreign reserves will be more than enough to stabilize the country’s financial system and currency, Cao said.

The free flow of capital will help Shanghai, the country’s biggest commercial city, boost trade and attract foreign capital while creating a new growth engine for the whole country, Cao said.

Details, details 

Little is known about how the 28 square kilometer Shanghai free trade zone will operate in reality but details are expected to be revealed during the Communist Party Central Committee’s third plenary session.

The zone was given the go-ahead by the State Council in a meeting chaired by Premier Li Keqiang {李克強} on July 3 and formally launched on Sept. 29. It is being touted as a pilot site to test the “innovative management model of the central government’s investment and trade policies”.

Cao said the zone can expect to be the regional headquarters of many multinationals looking to take advantage of the area’s zero tariffs. “That is exactly the model that Hong Kong adopted in the 1980s… In the next three to five years, Shanghai will emerge as a regional trade hub that is much more competitive and is on a larger scale than Hong Kong,” he said.

He said rising competition meant Hong Kong would be better off repositioning itself as a trade hub to serve countries in Southeast Asia — a growing source of trade for China — instead of focusing on trade between China and North America.

Zhang agreed that Shanghai’s future is as a major international financial hub, a goal that the city expects to meet by 2020, according to its 12th five-year plan. But reaching that goal means the authorities should open the capital account soon so that the financial system of the zone, city and country can grow. 

For some observers, this is a chicken-and-egg issue. A free trade zone without the free flow of capital will not be attractive to foreign investors but opening the capital account without the support of a market economy will allow large-scale capital outflows when situations like a global financial crisis or US interest rate hike hit. 

Most foreign banks have adopted a wait-and-see approach on whether to set up a branch in the zone. Only two offshore lenders, Citigroup and DBS, have applied for and secured a license to open branches in the zone. 

More investment options

The controversial issue won’t be going away any time soon — unlike the 21st Century Business Herald’s May 21 report containing Zhou’s proposal for renminbi convertibility. 

Zhang Liqing {張禮卿}, dean of the school of finance at the Central University of Finance and Economics, is one of those advocates of waiting. He told a forum in Beijing on Nov. 1 that China is not yet ready to open its capital account because the lack of investment channels means domestic capital will leave the countryChina should first establish a real market economy by ridding the financial, insurance and telecom sectors of monopolies and opening the doors to a wider range of investors, he said. 

Cao agreed that Beijing needs to — and will — make a move on monopolies soon. When it does, he said, the central government can look to Alibaba Group and Tencent Holdings Ltd. (00700.HK) – which offer retail, logistics and financial services – as examples of the kinds of businesses that can create a successful economic core for the next decade. 

– Contact the reporter at [email protected]

This is the final part of a series of articles on CPC’s Third Plenary Session.


Chief reporter at EJ Insight

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