Good morning, ladies and gentlemen.
It is my great pleasure to open this conference on 'capital
account liberalisation: international experience and implications
for China'.
This conference is taking place at a crucial time, as one of the
most tumultuous periods in the financial history has put to test
our ability of crisis management. Even as governments across the
world keep their focus on the immediate task of stabilising
financial markets and supporting economic growth, wide-ranging
discussions are already under way as to what lessons can be drawn
from the crisis. These discussions are likely to affect many
aspects of policy thinking on how best to monitor and manage risks
in the financial system in order to achieve sustained economic
growth and prosperity.
The topic of this conference - the costs and benefits as well as
experiences of capital account liberalisation - is likely to be one
such area of intense interest, particularly from emerging markets'
point of view. As financially more closed economies have been less
affected so far by the global turmoil, the merit of financial
liberalisation and greater opening up to the rest of the world by
the emerging economies has been questioned. Indeed, this crisis has
brought us to a juncture where a better understanding of capital
account liberalisation - through learning from in-depth analysis
and open debates - is required in order to formulate better
policies in the area.
The potentially destabilising effects that capital flows could
inflict on the domestic economy are widely recognised. When it
rains, it pours: as noted by an NBER research, capital flows tend
to be pro-cyclical.* Large influxes of capital could push up the
value of currencies, drive up inflation and fuel asset bubbles,
while affecting the competitiveness of the export sector, posing
challenges to the authorities of the host country in managing
domestic monetary conditions and maintaining financial stability.
Capital flows can also quickly reverse, often driven by changes in
market sentiment or external environment. The 'sudden stops' of
capital flows have, in recent decades, brought severe financial
stress to emerging markets, with substantial costs to the real
economy. Such volatility is perhaps one main reason why the
cross-country studies on growth benefits of a more open capital
account have remained largely inconclusive. The current financial
crisis brings home the message that integration with the global
financial market could expose a country to global financial
turbulence even when its own financial sector and real economy are
fundamentally sound.
Despite the recent turbulence and the spillover effects of
capital flows, we should not, in my view, lose sight of the many
benefits of an open capital account. Free flows of capital across
borders can make the domestic financial market deeper and wider,
increase liquidity, and facilitate price discovery, thus improving
efficiency of resource allocation. At the same time,
diversification by investing overseas can help raise investment
returns for households, which would in turn help promote private
consumption and support sustainable growth. For emerging markets in
particular, participation of foreign financial institutions can
speed up the learning process and facilitate the adoption of best
international practices by the financial sector. Therefore, while a
more liberal regime for capital flows could at times bring about
negative impacts, the relevant response should not be to keep the
capital account closed forever, but to find ways of effectively
managing the potential risks.
International experiences have provided some broad suggestions
on how such risks could be managed. Foremost is the importance of
appropriate sequencing between liberalising the capital account and
other domestic reforms. Development of financial institutions and
markets, enhanced macroeconomic stability, and proper risk
management by banks and enterprises would help to increase the
resilience of the domestic entities in dealing with volatile
capital flows. In addition, prudential regulation and supervisory
framework need to be established, in order to prevent excessive
risk-taking by domestic financial institutions. Such framework
needs to be accompanied by adequate accounting, auditing and
disclosure standards, to improve market transparency and enhance
supervisory effectiveness.
Turning to Mainland China's experience, the liberalisation of
capital account has been selective. Inflows of foreign direct
investment have long been encouraged, which has contributed
significantly to China's robust economic growth. In more recent
years, steps have been taken by the authorities to allow greater
portfolio flows. In particular, the Qualified Foreign Institutional
Investors (QFII) schemes have enabled foreign investors to access
the domestic financial market, while under the Qualified Domestic
Institutional Investors (QDII) schemes, financial institutions can,
upon approval, invest overseas on behalf of domestic investors.
Reflecting the limited channels of outward investment and market
conditions, however, capital flows have been overwhelmingly inward
bound in recent years, and China has experienced a rapid
accumulation of foreign exchange reserves. This had fed into
pressures on the exchange rate and inflation which were only eased
somewhat by the global economic slowdown in more recent months. The
People's Bank of China has employed sterilisation through open
market operations, reserve requirements and credit quota in order
to offset the impact of capital inflows on domestic monetary
conditions. Such measures, however, have incurred costs to the
central bank and the banking sector. Thus it would be useful to
consider ways in which outflows of capital can be liberalised in an
orderly and regulated manner to alleviate the BOP pressures in the
near term. From a longer term perspective, greater financial
integration with the rest of the world is probably inevitable, with
China now becoming the fourth largest economy and the third largest
trading nation. Indeed, large financial crises in the past such as
the Mexican crisis of 1994 and Asian crisis in 1997-8 have not
prevented global financial integration.
An open capital account has been generally considered as an
ultimate policy objective in the Mainland, as its many benefits are
well recognised. However, there have been lots of debates mostly
with regard to the pace of the reforms. Although the stable
macroeconomic conditions, the improvement of the financial
institutions' balance sheets, and the enhanced supervisory
framework in recent years have increased the economy's resilience,
there are vulnerabilities. Most notably, financial market
development and the price discovery mechanisms are still at their
early stage, and the risk management capacity of the financial
institutions and the corporate sector remains limited. It is
therefore understandable that Mainland policymakers would prefer a
gradual, controllable process in capital account liberalisation, in
order to reduce the shock on the domestic financial system from
capital flows.
Hong Kong fits well into this prudent strategy. It is well
positioned to help the Mainland to manage the process of
liberalisation, while ensuring important reforms move forward
steadily. This unique role derives from Hong Kong's proximity with
the Mainland and shared culture and language, the close cooperation
of the financial authorities of the two sides, and importantly,
Hong Kong's status as a well-established international financial
centre. I will point out two particular areas for such
cooperation.
First, Hong Kong can be used as a platform for pilot schemes for
further expansion of cross-border fund flows. The use of Hong Kong
as a financing platform has played an important role in Mainland's
economic development and a continued and expanded use should be
made going forward. In addition to the well developed platform for
Mainland enterprises to list on the Hong Kong's stock exchange,
consideration could be given to facilitate SMEs to raise funds
through bond issuance with credit enhancement in Hong Kong. At the
same time, Hong Kong can serve as a platform for more investment
outflows from the Mainland, which would improve investment choices
for Mainland investors. For instance, financial instruments issued
in Hong Kong could be allowed to be listed on the Mainland, or
Mainland investors could be allowed to use their own foreign
currency deposits to invest overseas through Hong Kong.
Second, Hong Kong can be a testing ground for the international
use of the renminbi, a process closely related to Mainland's
capital account liberalisation. The renminbi business scheme in
Hong Kong, which is supported by a clearing arrangement provided by
the People's Bank of China, has developed steadily since its launch
in early 2004. It has now extended from personal banking to bonds
issuance by Mainland financial institutions. Renminbi deposits in
the Hong Kong banking system have also risen significantly over the
last few years. Further expansion of renminbi business into trade
settlement and related financial services would bring convenience
for traders and enterprises on both sides. More importantly, it
will help to lay the ground work for the use of renminbi for trade
related activities through a formal and supervised channel.
The demand for a wider use of renminbi outside the Mainland is
likely to increase further as the Mainland economy grows. In
addition, the recent global financial turmoil has highlighted the
need for a more diversified international monetary system,
including more currency choices for international transactions. In
time renminbi could be one of the obvious choices for many
countries. In this process, using the well-established
institutional framework of renminbi business in Hong Kong for pilot
schemes will enable better monitoring and assessment of the flows,
and mitigate the potential risks particularly on the domestic
monetary policy management.
One important pre-requisite for designing appropriate policies
to facilitate the Mainland's capital account opening is a good
understanding of the economy and financial system. Here at the
HKMA, we have closely monitored, as well as undertaken in-depth
analytical work on the Mainland economic, monetary and financial
developments. Our Half-Yearly Financial Stability Report has a
section devoted to the Mainland economy, and research reports on
the Mainland are published as working papers available on our
website. We also started in 2006 a China Economic Issues series
dedicated to detailed analysis of economic and financial market
issues in the Mainland. This conference series is also a good way
to organise informed discussions on the Mainland's financial sector
issues.
The first part of the conference examines the experiences of
Chile, India, Korea and Thailand in their capital account
liberalisation, with the view of drawing useful lessons for
Mainland China. The second part focuses on the Mainland, assessing
the effectiveness of current policies in dampening the impact of
capital inflows on the domestic economy, their costs, as well as
policy options of outward investment. A final paper will gauge the
current level of financial integration between the Mainland and
Hong Kong, and discuss the policy implications. I am pleased that
this conference has brought together a group of experienced
researchers and policymakers from a wide range of central banks,
international organisations and research institutes. As earlier
noted, the recent global financial turmoil will probably turn out
to be the most critical time in recent economic history which will
shape future economic and policy thinking. I hope this conference
can provide a useful platform for fruitful discussions on capital
account liberalisation to enhance our understanding on the
issue.
I wish the conference great success.
*Kaminsky, G.L., C.M. Reinhart and C.A. Vegh (2004), "When it
rains, it pours: procyclical capital flows and macroeconomic
policies", NBER Working Paper, 10708
