China’s fi­nan­cial flood­gates

Financial Mirror (Cyprus) - - FRONT PAGE -

As China’s econ­omy starts to slow, fol­low­ing decades of spec­tac­u­lar growth, the gov­ern­ment will in­creas­ingly be ex­posed to the siren song of cap­i­tal-ac­count lib­er­al­i­sa­tion. This op­tion might ini­tially ap­pear at­trac­tive, par­tic­u­larly given the Chi­nese gov­ern­ment’s de­sire to in­ter­na­tion­alise the ren­minbi. But ap­pear­ances can de­ceive.

A new re­port ar­gues that the Chi­nese au­thor­i­ties should be skep­ti­cal about cap­i­tal-ac­count lib­er­al­i­sa­tion. Draw­ing lessons from the re­cent ex­pe­ri­ences of other emerg­ing coun­tries, the re­port con­cludes that China should adopt a care­fully se­quenced and cau­tious ap­proach when ex­pos­ing its econ­omy to the caprices of global cap­i­tal flows.

The common thread to be found in the re­cent his­tory of emerg­ing economies – be­gin­ning in Latin Amer­ica and run­ning through East Asia and Cen­tral and East­ern Europe – is that cap­i­tal flows are strongly pro-cycli­cal, and are the big­gest sin­gle cause of fi­nan­cial in­sta­bil­ity. Do­mes­tic fi­nan­cial in­sta­bil­ity, as­so­ci­ated with lib­er­al­i­sa­tion, also has a large im­pact on eco­nomic per­for­mance, as does the lack of con­trol over non-bank fi­nan­cial in­ter­me­di­aries – an is­sue that China is now start­ing to face as the shadow bank­ing sec­tor’s con­tri­bu­tion to credit growth be­comes more pro­nounced.

Most aca­demic re­search also sup­ports the view that fi­nan­cial and cap­i­tal-ac­count lib­er­al­i­sa­tion should be un­der­taken war­ily, and that it should be ac­com­pa­nied by stronger do­mes­tic fi­nan­cial reg­u­la­tion. In the case of cap­i­tal flows, this means re­tain­ing cap­i­tal-ac­count reg­u­la­tions as an es­sen­tial tool of macroe­co­nomic pol­icy.

In­deed, dur­ing the 1990s, China – and also In­dia – taught the rest of the de­vel­op­ing world the im­por­tance of grad­ual lib­er­al­i­sa­tion. It was a les­son that many coun­tries fully learned only in the wake of the eco­nomic and fi­nan­cial crises that be­gan in East Asia in 1997, spread to Rus­sia in 1998, and af­fected most of the emerg­ing world. By main­tain­ing strong cap­i­tal-ac­count reg­u­la­tion, China avoided the con­ta­gion.

Even the In­ter­na­tional Mon­e­tary Fund, in late 2012, adopted a cau­tious ap­proach. The IMF now recog­nises that cap­i­tal-ac­count lib­er­al­i­sa­tion comes with risks as well as ben­e­fits, and that “lib­er­al­i­sa­tion needs to be well planned, timed, and se­quenced in or­der to en­sure that its ben­e­fits out­weigh the costs.” More­over, the Fund now re­gards cap­i­tal-ac­count reg­u­la­tions as part of the broader menu of macro-pru­den­tial mea­sures that coun­tries should be free to use to pre­vent eco­nomic and fi­nan­cial in­sta­bil­ity.

To the ex­tent that cap­i­tal-ac­count vo­latil­ity is the ma­jor pro-cycli­cal fi­nan­cial shock in emerg­ing economies, reg­u­la­tion should be the ma­jor macro-pru­den­tial in­stru­ment used to counter it. Th­ese reg­u­la­tions should com­ple­ment, not sub­sti­tute for, other coun­ter­cycli­cal macroe­co­nomic poli­cies. The IMF rec­om­mends giv­ing higher pri­or­ity to those other poli­cies, whereas we have pre­vi­ously rec­om­mended us­ing them and cap­i­tal-ac­count reg­u­la­tions simultaneously.

It is not just emerg­ing mar­kets that have had to pay heed to the dan­gers of rapid lib­er­al­i­sa­tion. Ja­pan’s ex­pe­ri­ences also of­fer valu­able lessons about the im­por­tance of pru­dence in cap­i­tal-ac­count lib­er­al­i­sa­tion for a cur­rency in in­creas­ingly high de­mand in­ter­na­tion­ally. For an ex­tended pe­riod, Ja­pan al­lowed only strongly reg­u­lated fi­nan­cial in­ter­me­di­aries to man­age cap­i­tal flows, ef­fec­tively dis­cour­ag­ing the in­ter­na­tional use of its cur­rency. And when a tsunami of cap­i­tal looked set to flood the econ­omy, pol­i­cy­mak­ers did not shy away from try­ing to con­tain the in­flows.

In a sense, Western Europe was once in the same boat. Its cap­i­tal-ac­count lib­er­al­i­sa­tion was also a long-term process, be­gin­ning with cur­rent-ac­count con­vert­ibil­ity in 1958 and end­ing with cap­i­tal-ac­count con­vert­ibil­ity in 1990. And it faced a cri­sis of its pay­ments sys­tem two years later that led to sig­nif­i­cant de­pre­ci­a­tion for some coun­tries’ cur­ren­cies.

None of this is in­tended to sug­gest that the in­ter­na­tion­al­i­sa­tion of the ren­minbi should not take place in the fore­see­able fu­ture. Given the im­por­tance of China in the global econ­omy, the de­nom­i­na­tion of an in­creas­ing share of trade and in­vest­ment in ren­minbi seems in­evitable. But China’s au­thor­i­ties should man­age that process grad­u­ally, choos­ing the spe­cific chan­nels through which it should take place.

In­deed, China is per­haps the most suc­cess­ful ex­am­ple in his­tory of grad­ual and prag­matic eco­nomic trans­for­ma­tion. It should not al­low it­self to be tempted from its tried and tested course by calls for a pol­icy that has led too many emerg­ing economies onto the rocks.

Newspapers in English

Newspapers from Cyprus

© PressReader. All rights reserved.