China’s yuan experiment faces risks and legacy
CHINA’S plan to test yuan convertibility in a new services hub being built near Hong Kong fanned excitement Beijing may be dismantling its rigid capital controls sooner than expected. A reality check paints a different picture and suggests that China’s latest test bed carries risks that will make the country’s policymakers move slowly. The experimental zone of Qianhai - dubbed a $45 billion “mini Hong Kong” - will be a pioneer of the gradual opening up of China’s capital account.
While China controls capital moving in and out of the country, it will allow freer movements of the currency in and out of Qianhai in the southern city of Shenzhen. That was the plan announced by officials at the weekend with much fanfare in a series of policy incentives to mark the 15th anniversary of Hong Kong’s return to China. But analysts point to potential risks and cite setbacks from similar experiments.
Chinese officials, including the central bank chief, have also expressed caution suggesting Beijing is likely to roll out any changes in baby steps, which have characterized the country’s economic liberalisation. The biggest challenge for authorities will be to prevent companies from exploiting the zone, from inside or outside the area, because of the easier terms on capital account transactions, said economist Zhao Qingming. “Once you open a hole in the capital account in a certain area, it means the capital account is open for all of the people,” Zhao, of China Construction Bank in Beijing, said.
The 15-square-kilometre area zoned for the test bed is currently a barren stretch of reclaimed land. Under the plans, basic infrastructure will be put in place by 2015 and it will become a global services hub by 2020 with financial services identified as the top sector to develop. Details on how the zone will operate are sketchy. Chinese officials have said firms located in Qianhai can experiment with cross-border yuan transactions. They will be allowed to borrow or issue yuan bonds in Hong Kong, opening up a market now only available to some state-owned banks and companies. It is not clear either how Qianhai will proceed with capital-account convertibility - whether firms in the zone will be allowed to convert yuan freely into foreign currencies and vice versa.
China’s yuan is convertible under the current account, the broadest measures of trade in services and goods. But it maintains tight restrictions on the capital account, particular on debt and portfolio investment, worried that freeing up the yuan too quickly could leave the economy vulnerable to rapid movements in capital in and out of the country. This year Beijing agreed to allow all trade to be settled in yuan, following a series of regional experiments.
It has set up a number of currency swap agreements with countries to support settlement in yuan. It has also taken steps to relax its tight grip on currency trading, gradually widening the permitted daily trading range for the yuan. In April, Beijing doubled the band to 1 percent either side of a mid point. Relaxing controls on the financial services industry and capital account convertibility presents a different test for authorities because much of the zone’s activity will be paperbased, or electronic transactions, that will be much more difficult to monitor.