The authors would like to thank Robert McCauley, William Gavin, conference participants at the Federal Reserve Bank of St. Louis and Tsinghua University Conference of “Monetary Policy in a Global Setting: China and United States,” and seminar participants at the China State Administration of Foreign Exchange for their comments on the paper. Thanks also go to Simon Chan for his excellent research assistance. The views expressed in this paper are those of the authors, and do not necessarily reflect those of the Hong Kong Monetary Authority, Hong Kong Institute for Monetary Research, its Council of Advisers, or the Board of Directors.
How would Capital Account Liberalization Affect China's Capital Flows and the Renminbi Real Exchange Rates?
Article first published online: 5 DEC 2012
© 2012 The Authors China & World Economy © 2012 Institute of World Economics and Politics, Chinese Academy of Social Sciences
China & World Economy
Volume 20, Issue 6, pages 29–54, November-December 2012
How to Cite
He, D., Cheung, L., Zhang, W. and Wu, T. (2012), How would Capital Account Liberalization Affect China's Capital Flows and the Renminbi Real Exchange Rates?. China & World Economy, 20: 29–54. doi: 10.1111/j.1749-124X.2012.12001.x
- Issue published online: 5 DEC 2012
- Article first published online: 5 DEC 2012
- capital account liberalization;
- exchange rates;
- net foreign asset position
In this paper we study the determinants of gross capital flows, project the size of China's international investment position in 2020, and analyze the implications for the renminbi real exchange rate if China liberalizes the capital account. We assume in this exercise that the renminbi will have largely achieved capital account convertibility by the end of the current decade, a timetable consistent with recent proposals by the People's Bank of China. Our analysis shows that if the capital account were liberalized, China's gross international investment position would grow significantly, and inflows and outflows would become much more balanced. The private sector would turn its net liability position into a balanced position, and the official sector would reduce its net asset position significantly, relative to the country's GDP. Because of the increasing importance of private sector foreign claims and the decreasing importance of official foreign reserves, China would be able to earn higher net investment income from abroad. Overall, China would continue to be a net creditor, with the net foreign asset position as a share of GDP remaining largely stable through this decade. These findings suggest that the renminbi real exchange rate would not be particularly sensitive to capital account liberalization as capital flows are expected to be two-sided. The renminbi real exchange rate would likely be on a path of moderate appreciation as China is expected to maintain a sizeable growth differential with its trading partners.