Official dismisses looser capital account fears

China's opening of its capital account will not generate an overwhelming net portfolio outflow, said Sheng Songcheng, chief of the statistics department at the People's Bank of China, in an article published on Thursday in the China Securities Journal.

Inflow pressure could actually be greater than outflow pressure, Sheng wrote in the article, partly because China's overly tight restrictions on capital mobility have curbed investment opportunities abroad. The restrictions have hindered some domestic companies' plans to expand abroad, merge with overseas companies, and get hold of advanced technology.

Moreover, China's current account has been generating a surplus, which will make up for the outflow deficit once the capital account is loosened.

Sheng also dismissed fears that loosening the capital account will lead to a financial crisis, citing reasons including China's outstanding economic growth, exchange rates that are not excessively overvalued, and a financial market large enough to stand the impact of a significant capital influx.

China would also be able to digest a surge in foreign investment, said Ding Zhijie, an economics professor at the University of International Business and Economics.

"Take securities for example, foreign investment takes only about 10 percent of the market at present. It would be only 20 percent even if the proportion doubles after the capital account opens up, which would still be quite small and wouldn't rival domestic capital," said Ding.

According to Ding, the opening of the capital account is unlikely to trigger huge increases in the amount of capital coming in or going out of China because not all items will be opened at the same time. Also, companies and individuals have their own opinions on when to make investments and where to put their money, which lowers the possibility of erratic capital flows.

Meanwhile, the market-oriented reform of interest and exchange rates should be on par with the opening of the capital account, said Sheng. They should be carried out at the same time.

Li Wei, an economist at Standard Chartered Plc, however, believes that removing the controls on interest and exchange rates should be a prerequisite for capital account loosening.

"If interest and exchange rates are not determined solely by the market, they cannot reflect the real situation or even cover up potential risks," Li said.

On the other hand, Sheng expressed caution in opening up the capital account. He suggested a gradual approach, citing three principles along the process.

"First, highly profitable accounts, such as foreign direct investment and investment overseas, could be opened earlier. Second, high-risk accounts, such as short-term foreign debt, can afford to wait. Lastly, supervision could be more flexible. Specific or temporary responses to specific situations should be allowed," Sheng wrote.

Li echoed Sheng's views regarding a progressive method, emphasizing that rules have to be formulated, though not overnight, to increase China's immunity to capital flow fluctuations, including regulations for shutting down troubled financial institutions and oversight on non-performing loans.