the full convertibility of the renminbi: sequence and impact

1

The Full Convertibility of the Renminbi: Sequence and Impact

Drafted by Shucheng Liu and Zhijun Zhao

Hong Kong Institute for Monetary Researchand

Economic Institute, Chinese Academy of Social Sciences

Research Project Group:

Yue Ma Associate Professor, Economics Department, Lingnan University

Yak-yeow Kueh Chair Professor, Economics Department, Lingnan University

Shu-ki Tsang Professor, Economics Department, Hong Kong Baptist University

Matthew Yiu Manager, Hong Kong Institute for Monetary Research

2

This paper was written while we were visiting Research Fellows at the

Hong Kong Institute for Monetary Research. We wish to thank the

HKIMR for their hospitality and support.

The views presented in this paper are those of the authors and do not

necessarily reflect those of the HKIMR.

1. Introduction

This paper discusses the sequence of the Renminbi’s full

convertibility and its possible impact on mainland

China’s economy and Hong Kong’s economy.

3

1. Introduction (Continued)

China’s entry into the World Trade Organization (WTO) will

effectively speed up the full convertibility of the Renminbi.

• Foreign banks will be allowed to make corporate loans in

local currency within two years of entry

• Foreign banks will be allowed to deal with individual Chinese

customers within five years after entry.

Some people thus point out that these measures mean the Renminbi

will soon become a fully convertible currency. We think this

viewpoint is incorrect.

4


It is because this viewpoint confuses the capital account

convertibility with the Renminbi’s full convertibility. It also

confuses removing restrictions on transactions with removing

restrictions on exchange.

The measures mentioned above are just important steps towards

removing restrictions on capital account transactions. They are

not yet equivalent to capital account convertibility and still far

from the Renminbi’s full convertibility.

5


The paper is organized as follows.

• Section Two focuses on the sequence of the Renminbi’s full

convertibility.

• Section Three develops a general equilibrium model for an

open economy.

• Section Four analyses the possible effects of the Renminbi’s

full convertibility on mainland China’s economy and Hong

Kong’s economy.

• Section Five provides the conclusions.

6

2. Sequence of the Renminbi’s Full Convertibility

A. A review of the experience of developed industrial countries B. Three stages in the Renminbi’s full convertibility

After World War , developed industrial countries Ⅱ

stepped towards the capital account convertibility in

a relatively cautious way.

(See Table 1 and Table 2)

7

Table 1 Currency’s Convertibility in Developed Industrial Countries (In Order of the Time When Establishing Capital Account Convertibility)

Countries

Time When Establishing Current Account Convertibility

Time When Establishing Capital Account Convertibility

Length of the Interval Between Current Account Convertibility and Capital Account Convertibility (years)

USA 1946 1973 27 Germany 1961 1975 14 Great Britain 1961 1979 18 Switzerland 1992 1980 - 12 Japan 1964 1980 16 Australia 1965 1983 18 New Zealand 1982 1984 2 Netherland 1961 1986 25 Denmark 1967 1988 21 France 1961 1989 28 Sweden 1961 1989 28 Austria 1962 1990 28 Italy 1961 1990 29 Belgium 1961 1990 29 Luxembourg 1961 1990 29 Norway 1967 1990 23 Ireland 1961 1990 29 Finland 1979 1990 11 Spain 1986 1993 7 Portugal 1988 1993 5 Greece 1992 1994 2 Iceland 1983 1995 12

8

Table 2 Currency’s Convertibility in Developed Industrial Countries (In Order of the Interval Time between Current Account Convertibility and Capital Account Convertibility)

Countries

Length of the Interval Between Current Account Convertibility and Capital Account Convertibility (years)

Italy 29 Belgium 29 Luxembourg 29 Ireland 29 France 28 Sweden 28 Austria 28 USA 27 Netherland 25 Norway 23 Denmark 21 Great Britain 18 Australia 18 Japan 16 Germany 14 Iceland 12 Finland 11 Spain 7 Portugal 5 New Zealand 2 Greece 2 Switzerland - 12

9

B. Three Stages in the Renminbi’s Full Convertibility

There does not exist a uniform or fixed sequence of the currency’s full convertibility due to the differences across countries.

At the same time, based on the common practice and basic sequence taken by most countries in the world, drawing on the experience and lessons from other countries’ practice and in view of the fact that China is a large developing country, we believe that a steady and carefully designed sequence is needed.

10

B. Three Stages in the Renminbi’s Full Convertibility (continued)

The whole course of the Renminbi’s full convertibility, we think, should be broken down into three major stages in general.

Stage One, Adopting current account liberalization. (It was established

by 1996.)

Stage Two, Adopting capital account liberalization. (It’s currently going on.)

Stage Three, Adopting the Renminbi’s full convertibility. (It will take place in

the future.)

As to the stage of current account liberalization and the stage of capital account liberalization, each should be further broken down into two successive steps.

Step One, Removing restrictions on current account or capital account

transactions.

Step Two, Removing restrictions on current account or capital account

exchange, namely adopting current account or capital account

convertibility. (See Table 3)

11

Table 3 Sequence of the Renminbi’s full convertibility

Stage One Current account liberalization

Step One Removing restrictions on transactions Step Two Removing restrictions on exchange

It was established by 1996.

Stage Two Capital account liberalization

Step One Removing restrictions on transactions Step Two Removing restrictions on exchange

It’s currently going on.

Stage Three Renminbi’s full convertibility

It will take place in the future.

12


Step One Removing restrictions on transactions

Removing current account restrictions on transactions

means removing restrictions on current international

transactions themselves and still retaining current

account restrictions on exchange, i.e. retaining the

examination and approval system relating to current

account exchange.

13


Step Two Removing restrictions on exchange

On the basis of having removed some or most of current account restrictions on

transactions, a country can further remove current account restrictions on

exchange, namely adopting current account convertibility. It means removing

the examination and approval system relating to current account exchange and

only retaining audit on the authenticity of transactions.

According to Article 8, Section 2(a) of the IMF’s Articles of

Agreement ， current account convertibility means that no member shall,

without the approval of the Fund, impose restrictions on the making of

payments and transfers for current international transactions.

14


Step One Removing restrictions on transactions

Removing capital account restrictions on transactions means removing restrictions on capital international transactions themselves and still retaining capital account restrictions on exchange, namely retaining the examination and approval system relating to capital account exchange.

China has been generally on the process of removing capital account restrictions on transactions. In 1979, it began to reform and open to the outside world. In 1996, it established current account liberalization.

15

After China’s entry into WTO, a number of restrictions on capital account transactions

will be lifted. The main measures are as follows:

Direct investment aspect:

(1) Foreign banks will be allowed to engage in joint ventures immediately upon entry.Restrictions on percentage of foreign equity stakes in banking will be lifted within fiveyears after entry.

(2) The new policy would allow multinational corporations to invest in large- andmedium-scale state-owned enterprises and to increase their equities above the 49 per centceiling on most state-owned enterprises except companies in certain key industries.

(3) The new policy would lift restraints on foreign enterprises taking out Renminbi-denominated project financing.

(4) China will open its insurance sector. Foreign insurance companies would bepermitted to hold up to 50 per cent of life insurance joint ventures with local companiesimmediately upon entry. Foreign non-life insurers would be allowed to hold 51 per cent ofSino-foreign joint ventures upon WTO entry, and would be allowed to establish wholly-owned subsidiaries within two years. Geographical restrictions on foreign insurancecompanies would be phased out within three years of entry. Within five years, foreigninsurance companies would be allowed to expand into group, health and pensioninsurance.

16

(5) China will open other service sectors, including telecommunications, trade andtourism besides banking and insurance.

(6) The new policy would expand the range of services and trade sectors in thewestern part of China that would be opened to foreign enterprises.

Portfolio investment aspect:(7) China has opened the door for foreign venture-capital firms to directly establishsuch funds. New regulations will allow them to take their venture-capital companiespublic on the Chinese equity market.

(8) Foreigners could invest in the Chinese brokerages in 2004.

(9) Foreigners would be allowed to invest directly in the domestic stock market by2006.

(10) A foreign-invested joint-stock limited company which meets requirementswould be allowed to issue A or B shares domestically.

17

Other investment aspect:(11) Foreign banks will be allowed to conduct domestic currency business withChinese firm within two years after entry and then with Chinese individual withinfive years of entry.

(12) Geographic restrictions on foreign banks will be lifted after five years. Foreignbanks will be allowed to offer Yuan services in four cities upon accession, withfour more cities added each year thereafter. Nationwide market access is due in fiveyears.

(13) Foreign banks may capture more than half the domestic market for fee-basedbanking services such as trade financing, credit card transactions and cashmanagement.

(14) Foreign-funded financial institutions would be allowed to provide creditguarantees and foreign-funded enterprises would be permitted to provide foreign-exchange collateral.

18

Stage Two Capital account liberalization Step One Removing restrictions on transactions (continued)

Note that the measures mentioned above are just important steps towards

removing restrictions on capital account transactions. They are not yet

equivalent to capital account convertibility and still far from the Renminbi’s

full convertibility.

For instance, by that time, resident individuals may be able to deposit

Renminbi in foreign banks residing in China, but what they can draw from the

banks is still Renminbi and not foreign currency. If resident individuals want

to draw out foreign currency to pay for capital international transactions, they

still need, in accordance with the China’s relevant regulations, to go through

the procedures relating to exchange.

19


Step Two Removing restrictions on exchange

On the basis of having removed some or most of capital account

restrictions on transactions, a country can further remove capital account

restrictions on exchange, namely adopting capital account convertibility.

It means removing the examination and approval system relating to capital

account exchange and only retaining audit on the authenticity of

transactions.

Until now, there still exist strict capital account exchange restrictions that

need to be lifted up step by step in due course.

20

Stage Two Capital account liberalization Step Two Removing restrictions on exchange (continued)

(1) Direct investment

Regarding foreign direct investment, some exchange restrictions have

been lifted up already.

The remaining restrictions are the prohibitions against the remittance of

foreign exchanges into China as an investment by overseas legal persons

or natural persons. These foreign exchanges could only be settled with the

approval of the State Administration of Foreign Exchange (Regulations on

the Administration of Settlement, Sales and Payment of Foreign Exchange).

21


(1) Direct investment

Concerning China’s direct investment abroad, current exchange restrictions are also very strict.

Under the existing rules, when making an investment abroad, institutions residing in China shall receive an audit on the source of their exchange capital by foreign exchange administrative agency. (Rules on Foreign Exchange Administration of the People’s Republic of China)

22


(2) Portfolio investment

With regard to issuing securities to foreigners and opening

domestic securities market, exchange restrictions are still very

strict. Under the existing rules, foreign exchange received

from issuing foreign currency stocks and bonds could not be

settled without the approval of State Administration of

Foreign Exchange (Regulations on the Administration of Settlement, Sales

and Payment of Foreign Exchange).

23


(2) Portfolio investment

With respect to purchasing foreign securities, exchange restrictions are

also very strict. Under the existing rules, institutions and individuals

residing in China are forbidden to buy foreign exchange for the purpose

of purchasing foreign currency stocks issued abroad.

(Circular on Relevant Issues Regarding Perfecting Foreign Exchange Administration Relating to Capital Account.)

(Provisional Measures on Foreign Exchange Administration Relating to Individuals Residing in China.)

24


(3) Loans

For loans, restrictions on exchange are also extremely strict currently.

Under the existing rules, without the approval of State

Administration of Foreign Exchange, institutions residing in

China could not deposit abroad the raised international

commercial loans, use them for overseas direct payment or

convert them into Renminbi (Measures on the Administration of Raising

International Commercial Loans by Institutions Residing in China).

25


We can see from the above analysis that on the

whole, there is still a lot to do in the removal of

various restrictions on capital account transactions

and exchange. The removal of restrictions cannot be

accomplished in a single action.

26

Stage Three The Renminbi’s full convertibility

The Renminbi’s full convertibility means removing in all

respects exchange controls relating to the Renminbi,

removing audit on the authenticity of current account and

capital account transactions and allowing the Renminbi’s

convertibility without the occurrence of any real transactions.

This clearly could not be established within five years after

China’s entry into WTO.

27

3. A General Equilibrium Model for an Open Economy

Adopting the Renminbi’s full convertibility will involve a very broad

range of areas, including macro-economy and micro-economy, real

economic activity and financial activities, internal and external economic

balances, price, interest rates and exchange rates, etc.

In order to analyze the possible effects of the Renminbi’s full

convertibility on mainland China’s economy and to analyze the

interaction between the Chinese economy and its foreign counterpart such

as Hong Kong, we will develop an open macroeconomic general

equilibrium model with micro foundations. Each economy in the model is

assumed to be composed of a representative consumer and a firm.

28

The Behavior of a Representative Consumer

T h e o b j e c t i v e o f a r e p r e s e n t a t i v e c o n s u m e r i s t o m a x i m i z e t h e

p r e s e n t v a l u e o f h i s l i f e u t i l i t y tU :

)/()/()/(

)]/()()([

,,,,,,

,,,,

shsschscsccshssch

tsscsccschsscc

tst

PqMuPMuPqBu

PBuCquCuU

654

321

( 1 )

T h e r e p r e s e n t a t i v e c o n s u m e r i s b o u n d b y a f l o w b u d g e t c o n s t r a i n t a t

t i m e t :

ttct

tt

PqPrwq

qq

,h1-tch,1-th,t,1-tcc ,1-tc ,th,1-tch,tch,

tc ,1-tcc ,tcc ,th,1-tch,tch,tc ,1-tcc ,tcc ,tch,tcc ,

/Br/B)/PM-(M

)/PM-(M)/PB -(B)/PB-(BCC

( 2 )

29

The Behavior of a Representative Firm

T h e o b j e c t i v e o f a r e p r e s e n t a t i v e f i r m i s t o m a x i m i z e h i s p r o f i t s Pr :

1,c,c,hc,cc,ch,cc )1)(()(Pr tttttt wibbkkA ( 3 5 )

T h e r e p r e s e n t a t i v e f i r m i s b o u n d b y a f l o w b u d g e t c o n s t r a i n t

a t t i m e t :

tctcctcttcc bbkqk ,h,,h, ( 3 6 )

30

Solution:

U s i n g t h e L a g r a n g e f u n c t i o n a n d s o m e a s s u m p t i o n s , w e g e t t h e e x p l i c i t s o l u t i o n f o r a r e p r e s e n t a t i v e c o n s u m e r :

t

tch qC 2

,

( 2 2 )

)1(1 ,

3,

tctcc i

b

( 2 3 )

t

tth

tcht

q

qi

bq1

,

4,

)1(1

( 2 4 )

o r

t

tth

ttch

q

qi

qb

1

4

11

1

)( ,

,

( 2 5 )

1,

5, /1

tc

tccm

( 2 6 )

1

1

6

1

1

tht

tttch

q

qqm

,

,

/

( 2 7 )

31

Solution:

Using the Lagrange function and som e assum ptions, we get the explicit solution for a representative firm :

1,1,

11

,,ch

11

,,

)1(

)1(

1

tctc

ttct

tctcc

yw

qiA

k

iA

k

(38)

11

,

1

1

,

1

,1,

11

1

])1(1

[

ttc

ttctctc

qiA

qiA

iA

Ay

32

4. The Impact of the Renminbi’s Full Convertibility on Mainland China’s Economy and Hong Kong’s Economy A. The Impact on Mainland China’s Economy

The above general equilibrium model gives us an analytical

framework to study the impact of the Renminbi’s full

convertibility on mainland China’s economy.

Through model analysis, we will further find that several

conditions are necessary for the Renminbi to become fully

convertible, including appropriate macro-economic policy,

micro-sided enterprise reform, financial system reform, market-

oriented interest rate reform and more flexible exchange rate

policy, etc.

33

A. The Impact on Mainland China’s Economy

The process of the Renminbi’s full convertibility

will have an extensive effect on mainland China’s

economy.

As suggested by the experience of most countries in

the world, the most noticeable accompaniment of

capital account liberalization will be the massive

inflow of foreign investment.

34

A. The Impact on Mainland China’s Economy (continued)

I n o u r g e n e r a l e q u i l i b r i u m m o d e l , f o r e i g n i n v e s t m e n t i n f l o w i s r e p r e s e n t e d

b y e x t e r n a l b o n d i s s u e d b y d o m e s t i c f i r m s , b h c , t h e s o l u t i o n i s g i v e n b y

e q u a t i o n ( 2 9 ) .

)1(1 ,

3,

tch

hthc i

b

( 2 9 )

I n e q u a t i o n ( 2 9 ) , ( 1 + i c , t ) i s t h e r e a l i n t e r e s t r a t e o f t h e b o n d s i s s u e d a th o m e .E q u a t i o n ( 2 9 ) i n d i c a t e s t h a t f o r e i g n d e m a n d f o r d o m e s t i c b o n d s , b h c , i sp o s i t i v e l y r e l a t e d t o t h e i r r e a l i n t e r e s t r a t e , ( 1 + i c , t ) , t h a t i s , t h e h i g h e r t h er a t e o f r e t u r n o f d o m e s t i c b o n d s , t h e g r e a t e r t h e a m o u n t o f f o r e i g ni n v e s t m e n t i n t h e m . T h i s i s a n i m p o r t a n t r e a s o n f o r t h e i n f l u x o f f o r e i g ni n v e s t m e n t a f t e r t h e o p e n i n g o f c a p i t a l a c c o u n t .

35


With respect to the effect of massive inflow of

foreign investment, we can make an analysis

from two angles, namely the effect on real

economic activities and the effect on financial

activities.

We begin our analysis with the effect on real

economic activities.

36


T h e m a s s i v e i n f l o w o f f o r e i g n i n v e s t m e n t , n a m e l y a n i n c r e a s e i n b h c , w i l l

c a u s e a n i n c r e a s e i n d o m e s t i c c a p i t a l g o o d s . T h i s i s r e f l e c t e d i n t h e

e q u i l i b r i u m c o n d i t i o n ( 4 2 ) o f o u r m o d e l .

ttttt bbqkk ,hc,cc,ch,cc ( 4 2 )

T h e i n c r e a s e i n b h c w i l l l e a d t o t h e i n c r e a s e i n d o m e s t i c c a p i t a l g o o d s

( i n c l u d i n g c a p i t a l g o o d s p r o d u c e d a t h o m e , k c c , a n d c a p i t a l g o o d s i m p o r t e d

f r o m a b r o a d , k c h ) , w h i c h i n t u r n , t h r o u g h e q u a t i o n ( 3 4 ) o f o u r m o d e l ,

n a m e l y t h e p r o d u c t i o n f u n c t i o n , l e a d t o a n i n c r e a s e i n d o m e s t i c o u t p u t , y c .

][ ,,,

tchtcctc kkAy 1 ( 3 4 )

37


T h e i n c r e a s e i n d o m e s t i c o u t p u t , y c , w i l l , t h r o u g h e q u a t i o n ( 3 8 ) ,

f u r t h e r r e s u l t i n a r i s e i n d o m e s t i c w a g e , w c .

1,c1,c )1( tt yw ( 3 8 )

T h e r i s e i n d o m e s t i c w a g e w i l l , t h r o u g h c o n s u m e r s ’ b u d g e t

c o n s t r a i n t e q u a t i o n ( 2 ) , r a i s e d o m e s t i c c o n s u m p t i o n , C c c , a n d t h e

i n c r e a s e i n C c c w i l l , t h r o u g h c o n s u m e r s ’ o b j e c t i v e f u n c t i o n ( 1 ) , l e a d

t o a h i g h e r l e v e l o f c o n s u m e r s ’ w e l f a r e a n d u t i l i t y .

38


In the above chain-reaction, the most important links are

equation (42) and equation (34). The massive inflow of

foreign investment will not necessarily increase the real

productive capacity of capital and lead to an increase in

domestic output.

If the large-scale inflow of foreign investment is just in

pursuit of profits in the securities market or real estate

market, rather than ultimately entering the sphere of real

production, bubble economy will result.

39


As a consequence, certain preconditions, including (1) accelerating reform

of domestic enterprises with the liberalization of capital account, (2)

enhancing the efficiency of domestic enterprises in utilizing foreign

investment, and (3) promoting the healthy development of domestic

securities market so as to hold the bubble in check effectively, are needed

for the conversion of massive inflow of foreign investment into real

production capacity which will raise domestic output.

Without these preconditions, massive inflow of foreign investment may

cause some trouble.

40


We will make an analysis of the effect from the other angle

below, namely the effect on financial activities.

Massive inflow of foreign investment will lead to an increase

in domestic foreign exchange reserve, which will, under the

fixed exchange rate regime, result in an increase in the

corresponding issuance of the Renminbi. A large increase in

domestic money supply will cause inflation and affect real

exchange rate.

41


In our m odel, the form ula for real exchange rate is

tc

thtt P

Peq

,

, (3)

W e can see from form ula (3) that, w ith nom inal exchange rate, e, held constant

and w ith foreign price, P h , held constant, a rise in dom estic price level, P c, w ill

lead to a fall in the num erical value of real exchange rate, q .

For exam ple, w hen the exchange rate of the U S D ollar vs. the R M B changes

from R M B Y 8 / U S$1 to R M B Y 7 / U S$1, the R enm inbi has actually

appreciated. The fall in the num erical value of real exchange rate, q , nam ely

the real appreciation of the R enm inbi, w ill bring a rise in im port volum es [See

equation (22)(38)] and a fall in export volum es[See equation(28)(39)].

42


The trend of rising imports and falling exports will cause China to run a current account trade deficit, which will cause a real devaluation of the Renminbi.

A severe real devaluation of domestic currency may lead to the massive flight of foreign investment and even to the outbreak of financial crisis. Consequently, in the course of capital account liberalization, the Chinese government should adopt a more flexible exchange rate regime in order to avoid the occurrence of these problems.

The whole chain-reaction discussed above is shown at Figure 1.

43

Figure 1 Effect of Massive Inflow of Foreign Investment

Capital goods Eq.(42)

Output Eq.(34)

Wage Eq. (38)

Consumption Eq.(2)

Welfare Eq.(1)

Money supply

Real exchange rate Eq.(3)

Imports Eq.(22)(38) Exports Eq.(28)(39)

Real value of Renminbi

Foreign investment inflow Eq.(29)

44


In addition, in the course of capital account

liberalization, there also exist some other issues,

such as persistently deepening financial system

reform, enhancing the competitiveness of domestic

commercial banks, pursuing market-oriented interest

rate, and strengthening financial supervision.

Here in this paper, we do not intend to discuss these

issues in detail.

45

B. The Impact on Hong Kong’s Economy

The liberalization of China’s capital account

and the full convertibility of Renminbi will

undoubtedly have a far-reaching effect on

Hong Kong’s economic development. The

effect can be summarized as follows:

46

B. The Impact on Hong Kong’s Economy (continued)

(1) Direct investment aspect:

Until now, Hong Kong’s direct investment in the mainland has developed to

a certain scale. With the lifting of various restrictions on capital account

transactions and exchange, mainland China will provide the flowing-in

foreign investment with a wider range of investment opportunities and a

better legal and institutional environment, which is conducive to the further

expansion of Hong Kong’s direct investment in the mainland.

At the same time, the mainland will offer looser conditions for capital

outflow, which in turn increase mainland’s direct investment in Hong Kong.

Hence it helps promote Hong Kong’s economic development and benefit

local employment.

47


(2) Portfolio investment aspect:

When the mainland relaxes various restrictions on portfolio

investment, there must be development in the listing of foreign-

funded enterprises on the mainland stock market. In addition,

more mainland residents could purchase stocks and other

securities issued out of the territory. This will help Hong Kong’s

firms getting listed in the mainland and enlarge the size of Hong

Kong’s securities market.

48


Recently, that Hong Kong firms’ hope to get listed in the

mainland has become a hot issue in Hong Kong.

Chief executive of the Hong Kong Monetary Authority, Joseph

Yam (2001), once stated his views about this issue on the web

page of the Hong Kong Monetary Authority. He came up with

some instructive proposals on how the mainland should

gradually lift restrictions to enable Hong Kong’s firms to get

listed in the mainland.

49


He (Joseph Yam) also put forward some quite meaningful opinions on how to outline the sequence of financial liberalization.

He holds that, on one hand, rules designed to restrict the free flow or use of money are to be broken or to be circumvented so that further steps of liberalization should be taken. On the other hand, decision-makers should be careful about the pace of financial liberalization. Only when the attendant risks have been clearly identified and a prudent risk management mechanism has been put in place should the relevant steps, however beneficial, be taken.

50


(3) Imports and exports aspect:

With the mainland’s accession to WTO and its continuous

opening of capital account, the scale of imports and exports

of the mainland will be further enlarged. This will offer Hong

Kong more commercial opportunities. Thus Hong Kong’s

role as a bridge in the field of trade will be enhanced.

51


(4) Financial service aspect:

Just like the co-development of Hong Kong and Singapore in the past few decades as international financial centers; and like the co-functioning of London and Frankfurt, New York and Chicago, which jointly act as financial centers; Shanghai and Hong Kong will join their hands together in playing the role of international financial centers.

With the mainland’s entry into WTO, its continuous opening-up of capital account and the future full convertibility of the Renminbi, the overall scale of mainland’s capital inflow and outflow will dramatically be enlarged. This will not only favor the development of Shanghai as a newly rising international financial center, but also offer new and very large room for the further development of Hong Kong as a mature international financial center, due to the inadequacy of the mere reliance on Shanghai.

52


Influenced by the 1997 Asian Turmoil and the recent slowdown

in economic growth in major countries such as the United

States, the world financial market is in a phase of adjustment

and commercial opportunities will thus diminish. These would

drive some Hong Kong-based financial institutions to partly

transfer to Shanghai to seek new commercial opportunities.

Once the world economy regains its momentum, coupled with

the new development of the mainland’s economy, Hong Kong’s

financial industry will achieve new and greater development.

53


(5) New financial derivative instruments aspect:

The rapid globalization and intensified competition in global

financial market are encouraging constant development of

financial innovation. Hong Kong, as a well-grounded

international financial center which bears a specific

advantage, will play an important role in developing new

financial derivative instruments.

54


(6) Interregional links aspect:

Hong Kong is backed by the vast market of the mainland, especially the very large market of some southern provinces adjacent to it like Guangdong that are very closely linked to it in aspects of economy, history, culture and life. These southern provinces, Guangdong in particular, have achieved great development since the mainland’s opening-up and reform, and they are expected to gain further development with the mainland’s accession to WTO and its opening of capital account. This will also offer very large room for Hong Kong’s economic development.

55


(7) Qualified personnel aspect:

With the ever-expanding flow of fund, commodity and

information, qualified personnel flow is also getting enlarged.

In the presence of intensified competition in financial market,

commodity market and service market, qualified personnel

will surely play a more important role.

In order to retain the favorable position and bring it into full

play, Hong Kong should, in the long term, make greater effort

in the cultivation of qualified personnel.

56

5. Conclusion

I. There does not exist a uniform or fixed sequence in

adopting the full convertibility of a currency due to the

differences across countries. Based on the common

practice and sequence taken by most countries in the

world, and in view of the fact that China is a large

developing country, we conclude that a steady and

carefully planned sequence is needed for the full

convertibility of the Renminbi.

57

5. Conclusion (continued)

II. The process of the Renminbi’s full convertibility should bebroken down into three stages in general: The first one is theadoption of current account liberalization, which wasestablished by 1996; Second, is the capital accountliberalization which is currently going on; The third is theadoption of the Renminbi’s full convertibility, which willtake place in the future. For the course of liberalization ofboth current account and capital account, each should befurther broken down into two successive steps: First, liftingrestrictions on current account or capital accounttransactions; Second, lifting restrictions on current accountor capital account exchange, namely adopting currentaccount or capital account convertibility.

58


III. Foreign banks are allowed (1) to handle foreign exchange

business towards China’s enterprises in the same year that China

enters WTO; (2) to handle the Renminbi loan business towards

China’s enterprises within two years after China’s entry into

WTO; (3) to handle the Renminbi deposit and loan business

towards individuals residing in China within five years after

China’s entry into WTO. Some people thus utter that these

measures mean the Renminbi will soon become a fully

convertible currency. Our analysis shows that this utterance is

inaccurate.

59


IV. Achieving the Renminbi’s full convertibility will have

an extensive effect on mainland China’s economy. By

using the general equilibrium model, we find that a

series of preconditions are needed for the full

convertibility of Renminbi, including appropriate macro-

economic policy, micro-sided enterprise reform,

financial system reform, market-oriented interest rate

reform and more flexible exchange rate policy, etc.

60


V. Achieving the Renminbi’s full convertibility and hence the

promotion of mainland China’s economic development will

also have extensive effects on Hong Kong’s economy.

These effects, generally speaking, are conducive to

promoting Hong Kong’s economic development, though it

may also exert certain pressure on the transition of Hong

Kong’s economy, especially on the cultivation of qualified

personnel.

61


VI. With the mainland’s entry into WTO and with its continuous

opening-up of capital account and the future full convertibility of

the Renminbi, the overall scale of capital inflow and outflow of

the mainland will dramatically be enlarged. This will not only

favor the development of Shanghai as a newly rising

international financial center, but also, due to the inadequacy of

the mere reliance on Shanghai, offer new and very large room

for the further development of Hong Kong as a mature

international financial center. The economic recoveries of major

countries and the East Asia region, coupled with the new

development in the mainland’s economy, will bring new and

greater development to Hong Kong’s financial industry.

62

Thank you

very much.

the full convertibility of the renminbi: sequence and impact

Documents

currencys convertibility

capital account transactions

hong kongs economy

economics department

mainland chinas economy

industrial countries

open economy

monetary researchthis