By Chan Kung and He Jun*
In recent years, the dual factors of anti-globalization movement and intensifying geopolitical frictions have presented China’s economy a very different external environment compares with that in the past. In response to such change, China has begun to adjust its development priorities and strategies, with the “internal circulation” being the result of this adjustment.
Changes in the geopolitical environment also have important implications for China’s financial market development and financial openness, while this perspective is rarely considered by the conventional financial theory and financial regulation. If financial policymakers fail to take into account this new geopolitical framework, they are likely to misjudge the situation and this in turn will affect the effectiveness of the country’s financial openness.
According to a report of China Forex on February 19, Ye Haisheng, director of Capital Account Management Department at the State Administration of Foreign Exchange (SAFE), believes that the work plan of SAFE this year can be summarized in the following points: (1) Studying and proving the feasibility of allowing individuals in China to invest in foreign securities and insurance within the annual USD 50,000 facilitation quota. (2) Standardizing the management of domestic listing of red-chip enterprises, relaxing the restrictions on foreign exchange purchase and remittance of raised funds, in addition to clarifying the management rules of foreign exchange transactions made by foreign shareholders in reducing their holdings. (3) Revising foreign exchange management of foreign investors’ strategic investment in A-shares to facilitate the capital exchange operations. (4) Formulating a pilot program for integrated domestic and foreign currency pools of multinational companies, and relaxing the restrictions on cross-border capital, purchase, and settlement of foreign exchange, and use of capital while raising the entry threshold. (5) Prudently promoting the opening-up of the Chinese financial derivatives market to the outside world, and studying the appropriate relaxation of the restriction that foreign institutional investors can only conduct futures trading based on the hedging principle. (6) Timely increasing the total QDII quota, flexibly grasping the pace and scale of quota issuance according to the foreign exchange situation, so as to meet the cross-border asset allocation needs of domestic market entities. (7) Supporting the development of securities companies and giving full play to their active role in the foreign exchange market.
The work plan indicates SAFE is trying to further open-up China’s financial markets and make financial services more convenient for enterprises and individuals through a series of prudent reforms. Though being considered as the “world’s factory”, China is gradually losing its selling point of attracting foreign investment, therefore financial opening-up measures are important to attract foreign investment into the Chinese market and maintain its attractiveness to international capital. As a result of these reform measures, China has continuously loosened foreign exchange “controls” to facilitate its cross-border capital flows, which will objectively improve the investment environment in the Chinese market. From the perspective of market-oriented reforms, these reforms should indeed be advanced.
China’s accelerated construction of a high-standard market system may also be one of the important reasons for the aforementioned opening-up of foreign exchange management. The plan to build high-standard market system is seen by the country’s policymakers as an inevitable choice for deepening reform and opening-up and improving the socialist market economy. It is also an urgent requirement for building a new development pattern featuring internal circulation as the main body while mutually reinforcing dual circulation. Under this approach, SAFE will follow the “system integration” approach and carry out all-round and high-level opening-up pilot programs in some areas. In the pilot areas, a package of opening-up measures will be introduced, covering various fields such as cross-border trade, investment, and financing. The reform measures are similar to the opening-up approach, such as relaxing the business restrictions on individual capital accounts, abolishing the limit on annual foreign exchange purchase and payment, and studying the feasibility of allowing domestic individuals to invest in foreign securities and insurance within the annual USD 50,000 facilitation quota.
However, researchers at ANBOUND believe that these opening-up and relaxation measures may need to be promoted with a new perspective, i.e., a geopolitical perspective. Geopolitical pressures on China will persist in the foreseeable future due to the “two worlds” development pattern that will emerge as a result of the “vaccine war” and inherent risks to the Chinese economy. Taking these factors into account, the financial opening-up measures, which are perfectly sound from the perspective of market construction and conventional finance, could expose China to considerable capital flight if implemented. If this happens, it is likely to trigger systemic financial risks.
For example, China’s foreign exchange reserves were close to USD 4 trillion in 2014. With such ample foreign exchange reserves and the RMB in the midst of appreciation, China vigorously encouraged outbound investment, relaxed individual foreign exchange transactions, encouraged banks to lend abroad and Chinese enterprises rushed out to buy assets all over the world. This round of opening-up was accompanied by a massive capital flight, and China’s foreign exchange reserves fell sharply by USD 1 trillion in just about a year. With the sharp depreciation of the RMB in 2015 and the increased impact of capital flight, the authorities began to reverse their financial measures.
As an endorser of the market economy system, ANBOUND is not opposed to market opening-up, and as an independent think tank, we believe that under the new geopolitical and geo-economic environment, a broader framework of thinking is required to formulate national policies and reforms. It is necessary to analyze China’s future macro situation and potential risk environment from a geopolitical perspective to avoid misjudgment. In this regard, we believe SAFE’s assessment of the future may be too optimistic. Not only should we look at the “results” of foreign investment after the financial opening-up in recent years, but we should also evaluate China’s future situation from the perspective of geopolitical and long-term economic risks.
It should also be pointed out that the formulation of major economic policies requires further consideration of the near-term and long-term issues. In the past, we defined the near-term or the long-term with time frame. If something takes place in immediate future, it is defined as the near term; otherwise, it is defined as the long-term. However, the geopolitical situation in the world has changed. In the future, many geopolitical events are no longer a matter of time, but the scale and political effects of the events. The duration of the event may be very long, but the intensity varies. In other words, changes in capital markets will often be influenced by geopolitics. At this point, what affects the financial market is not technical financial knowledge and financial rules, and the capital flows only have little to do with the financial market. It is geopolitics that will play a dominant role, and geopolitics will be the dominant driver of capital markets. In short, what will affect the capital market in the future is not necessarily financial issue, but rather political issue.
Final analysis conclusion:
Unlike the past era of stable globalization, geopolitics has become the new framework for assessing the world today and in the future. China’s financial opening-up policy formulation needs to adapt to this change, and it needs to incorporate geopolitics into the framework of thinking and decision-making.
*Founder of Anbound Think Tank in 1993, Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
*Mr. He Jun takes the roles as Partner, Director of China Macro-Economic Research Team and Senior Researcher. His research field covers China’s macro-economy, energy industry and public policy.