Capital welcome, but beware of illegal inflow

Compared with other countries, China’s asset prices are very attractive, because of which the inflow of foreign capital is inevitable, China Banking and Insurance Regulatory Commission Chairman Guo Shuqing said at a news conference on Tuesday.

The scale of the influx of foreign capital is still within controllable range, Guo said, adding that the commission is taking more effective measures to, on the one hand, encourage cross-border capital flows, and on the other hand, prevent big fluctuations in the domestic financial market.

The message from the head of the banking and insurance industries watchdog comes at the right time, because the quantitative easing policy of the Federal Reserve is causing the flight of capital from the United States to other countries, causing overheating of the economy and asset bubbles. The US’ ability to upset financial stability elsewhere is quite strong, as shown by the financial crises it triggered in Latin America and Southeast Asia in the late last century through large-scale capital flow.

China suffered during the international financial crisis in 2008, becoming one of the major destinations for currency notes the US printed to bail out its economy. The money not only sought riskless arbitrage in the interest rate and exchange rate markets in China, but also rapidly pushed up housing prices in the country. It was only after the Federal Reserve claimed it was ending its quantitative easing policy in late 2014, propelled by China’s exchange rate reform, that speculative capital began to leave China in large numbers.

Now China is facing a similar situation. The US is losing control of its debt scale, and the excessive supply of government bonds will only prompt investors to dump the treasury bonds. The mounting inflation risks and the government’s heavy debts are spurring capital to escape from dollar assets to other countries, particularly China, which is the sole major economy with positive growth and showing considerable resilience.

As such, even though it should still welcome normal cross-border capital flows and foreign investment, especially in the sectors it needs, China must guard against the inflow of hot money, and the policymakers must adjust the financial policies to prepare for excessive inflow of foreign capital.

The real estate market and the staple commodity market are the key places to prevent systematic financial risks.