Opening doesn’t signify treaty signed due to coercion
The nation’s latest round of financial opening is impressive. According to the recently released negative list for foreign investment, the country has scrapped foreign ownership limits on Chinese-invested banks and allowed foreign banks to set up branches or subsidiaries in the country. The upper limits on foreign stakeholdings in domestic brokerages, securities investment fund management, futures companies and insurance firms have been eased to 51 percent. By 2021, all ownership limits will be removed.
For this reason, some reckon that the moves toward deregulation signify a treaty China signed with the US due to coercion amid bilateral trade rows. Some also say it’s a case of “crying wolf.” Both views are untenable. Financial opening is not something that’s just beginning today. It has progressed over the past 20 years. In the early stages of the country’s development when there were no solid economic fundamentals and international disturbances produced unbearable stress, it was necessary to control international capital, especially cross-border flows of short-term capital. Also, given the relatively small size of China’s financial institutions, which were insufficiently competent in professional terms at the time, the foray of foreign financial institutions was likely to entirely block their development. That made it necessary to restrict foreign financial institutions’ access to China.
But the country is now an upper middle-income economy and its financial sector has grown enormously. In the latest rankings by the The Banker magazine, China’s four largest banks hold the top four spots on the list of global commercial banks. China’s internet finance also holds the global lead and the country’s online payment sector in is particular is thriving. In light of this, financial opening won’t have an impact on China’s financial sector. The financial industry is known for its localization characteristics, meaning that it is highly dependent on local laws, culture and networks. China’s legal system is nothing like the legal frameworks in other countries. Additionally, China’s financial regulatory regime has unique traits, and the country’s consumption and market are different from those in other countries.
Therefore it’s less likely for foreign financial institutions to replace their domestic counterparts once they make inroads into the country. More importantly, Chinese financial institutions have established a strong network across the country, offering wide-ranging services both online and offline, such as payroll solutions and corporate loans. This makes it quite difficult for foreign financial institutions to penetrate into the country. Owing to the huge size of China’s market, domestic financial institutions sit on massive cash piles and rake in enormous gains, making them competent enough to cope with foreign competitors.
Worldwide, except for a few regions, a country’s financial system is largely dominated by domestic institutions. As measured by either its population, territory or its economic size, China is a huge country and is thus supposed to be more capable of assimilating foreign financial institutions. Over the past decade, foreign manufacturing companies have seen a continuing downward spiral in their market competitiveness in China. China’s financial institutions have a stronger competitive edge over domestic manufacturers, easing worries that domestic institutions might be squeezed out by their foreign rivals.
The logic behind those regarding financial opening as signing a deal under coercion is that the promise of opening up the financial space is like the signing of unfair treaties in the past under which foreign countries were offered huge benefits without giving corresponding rewards.
The logical error lies in the failure to observe that financial opening honors the country’s pledge to safeguard global free trade and will increase the economy’s operational efficiency.
To start with, the export-oriented development mode of the past three decades has resulted in a huge accumulation of savings, which raised domestic leverage ratios. Financial opening will mean the country can channel savings out and reap higher rewards in overseas financial markets and direct investment markets, preserving and increasing the asset value. Furthermore, the Chinese economy is undertaking a transition and upgrading and the absorption of developed countries’ technologies is considered a shortcut to achieving technological upgrading. The establishment of subsidiaries in China by foreign financial institutions is therefore able to serve as a bridge to capital and information for domestic businesses. Also, overseas financial institutions are disciplined in management terms and highly efficient, and their entry into China is expected to improve domestic institutions’ efficiency through competition and talent flows.
Prior to joining the WTO in 2001, there was a debate in the country about whether the “wolf was coming in,” but it turned out that such anxieties were unnecessary. Take the automobile industry, for instance. At the time, some thought that domestic carmakers wouldn’t be able to survive following auto tariff cuts. But the past 20 years have proved that domestic carmakers have not been eliminated but have made big strides, with the share of domestic cars going from virtually zero to more than 30 percent. The reason is that cars have changed from luxury items into necessities for middle-income families following tariff cuts. Meanwhile, the rapidly developing auto market has provided massive scope for growth for domestic carmakers.
Financial opening would produce similar effects. The plentiful portfolios of overseas financial institutions make them able to provide diversified fundraising vehicles for companies and individuals. If domestic institutions can emulate their foreign counterparts, China’s financial market will become a lot more sophisticated.
Certainly, financial opening by no means suggests immoderate opening. The country hasn’t abandoned control of capital flows under the capital account. The history since the Asian financial crisis of 1997 tells us that controlling short-term capital flows is a significant instrument for developing countries to hedge against international financial risks, and this instrument can’t be easily given up. But capital controls come at a cost, which lowers the efficiency of cross-border capital flows. Accordingly the country’s capital controls would only be partial except in emergencies. Additionally, the country won’t abandon its foreign exchange management. Reform efforts over the past four decades have taught us that the adoption of some intermediate regimes that fit our practical needs is one of the secrets of China’s economic success. The current financial opening is still proceeding in this mindset and will thus have a big chance of success.