Article/Huang Yiping, columnist of Sina Financial Opinion Leader (WeChat official account kopleader)
The experience of China's financial opening policy provides some important experiences and lessons, which can help China better design and implement policies in the next stage, and may also be useful for other emerging market economies that are opening up.
Starting from China's financial industry with all kinds of waste to be developed
On December 18-22, 1978, the Third Plenary Meeting of the Eleventh Central Committee of the Communist Party of China was held in Beijing. The meeting decided to shift the focus of work from class struggle to economic construction, thus starting the reform and opening policy that changed the fate of the country and the nation. However, in the early days of reform and opening up, the leaders did not have a clear blueprint for reform and could only "cross the river by feeling the stones". At that time, the financial system was not only isolated from the world, but only one financial institution, the People's Bank of China, accounted for 93% of the country's financial assets. At that time, the planned economy was implemented, and the allocation of funds between enterprises was decided by the government planning committee. In addition, people did not have much savings, so financial intermediaries could not play a role.
But this is not always the case in China's financial system. About 100 years ago, China's financial system was not only very developed, but also very open. In Shanghai, the international financial center, more than 100 countries' currencies were in circulation at one time. At that time, the silver standard system was implemented, and cross-border capital flows were completely free. The authorities did not directly control the quantity and price of money. However, in the 1930s and 1940s, the financial system basically collapsed due to the impact of the Great Depression and successive wars. Since 1952, financial institutions have been nationalized. Since 1956, almost all financial institutions have been cancelled in the socialist transformation movement.
At the end of 1978, China's financial industry was indeed in a state of waiting. However, at the beginning of the reform, the government focused on rebuilding the domestic financial system, including commercial banks, insurance companies and capital markets. Although the Japanese Export and Import Bank established a representative office in China as early as 1979, opening up was not a major part of China's financial policy for a long time. The first time that the government began to focus on the issue of financial openness was in the early 1990s. It mainly took two major measures: first, the dual track exchange rate was combined in early 1994 and the managed floating exchange rate system was implemented from then on; Second, the foreign direct investment policy of "market for technology" was implemented in 1993.
Of course, these two policies are not born out of nowhere. They both have a foreword story. The adjustment of the exchange rate probably began in 1980, when the exchange rate of RMB against the US dollar was 1.5:1, which was seriously overvalued. In order to encourage exports, the government set up an internal settlement price, which started the process of continuous devaluation of the official and market exchange rates, until the beginning of 1994 when they were combined to 8.7:1. The policy of attracting foreign direct investment originated from the Shenzhen Special Economic Zone established in 1980, but the special economic zone attracts foreign investment, mainly for export, and its target market is still abroad. The "market for technology" policy is to give up the domestic market and introduce capital and technology. From the perspective of attracting foreign investment alone, this policy was very successful. In the following 20 years, China has been one of the countries that attracted the most foreign direct investment in the world.
East Asia financial crisis
Capital account opening is shelved
Until now, the guiding principle of financial reform policy was basically closed. Although export was supported through exchange rate policy and foreign capital was attracted through various preferences, there was no substantial internal and external financial exchange. Only two or three years later, this pattern was broken. In the second half of 1996, Dai Xianglong, then the governor of the People's Bank of China, wrote to the IMF that China had realized the convertibility of RMB under the current account and was ready to achieve the convertibility under the capital account in another 5-10 years. The government also made clear the opening strategy of "first in and then out, first long-term and then short-term, first direct investment and then portfolio". Now to interpret the policy thinking at that time, we should take the European and American financial systems as the target model. Therefore, the direction of reform is to achieve "full convertibility".
Unfortunately, less than a year later, this seemingly methodical plan was disrupted by the sudden outbreak of the East Asian financial crisis. On July 31, 1997, the Thai baht was forced to depreciate significantly, which triggered the collapse of Asian currencies. The economies of Thailand, Indonesia, Malaysia and South Korea were all in the storm eye of the crisis, and the surrounding economies such as Hong Kong Special Administrative Region of China and Taiwan were also affected. The Chinese government immediately announced that it would fix the exchange rate of RMB to US dollar at 8.28 ∶ 1, which has made an important contribution to the stability of the regional currency market. Its brave behavior has also been highly recognized by the international community. But for understandable reasons, the plan of capital account opening can only wait for new opportunities.
But it may also be because China still kept capital account control at that time that it was prevented from catastrophic attack. At the same time, the Asian financial crisis has also provided China with some important enlightenment: First, if the domestic financial system is not yet sound, opening the capital account prematurely is tantamount to playing with fire. Second, an inflexible exchange rate system coupled with an overvalued currency is almost a drug that can probably trigger a balance of payments crisis. Third, at a critical juncture, sufficient foreign exchange reserves can save lives. Fourth, if there is too much external debt, especially short-term external debt, once confidence falters and capital flows back, it is easy to cut off financial stability. These lessons have more or less affected China's policy choices later.
In fact, China's financial system at that time was no better than Indonesia or South Korea. The average non-performing rate of commercial banks is as high as 30%~40%. The reason why there is no financial crisis in China is that in addition to capital account control, the government has also played a key role, so that the bad debt rate of banks is so high that there is no run. Therefore, on the one hand, the government has begun to accumulate a large amount of foreign exchange reserves for future emergencies; on the other hand, it has focused on resolving the risks of the banking system by writing off bad debts, injecting new capital, introducing international strategic investors, and finally listing in the international capital market. These two policies have achieved great success. The scale of foreign exchange reserves ranks first in the world, once as high as $4 trillion; Today, China's four state-owned commercial banks are among the top ten banks in the world.
In retrospect, I am still afraid that if the Central Bank had opened the capital account quickly in 1996, China might have become one of the "crisis countries" in 1997. After the outbreak of the East Asian financial crisis, the Chinese government has taken several countermeasures. Now it seems that they are still relatively wise choices: first, let the RMB temporarily peg to the US dollar to help stabilize the international financial environment; Second, the cross-border capital control has been partially tightened; Third, accelerate the accumulation of foreign exchange reserves; Fourth, we should deal with domestic financial risks as soon as possible, and the balance sheet of commercial banks soon improved significantly.
Entry into WTO
The opening of the financial service industry causes internal and external pressure
Although the East Asian financial crisis temporarily delayed China's capital account opening plan, it did not really change the direction of financial opening. At the end of 2001, China joined the World Trade Organization and made a clear commitment to opening its financial service industry to foreign capital. For example, in the banking industry, the Chinese government has promised to open RMB business to foreign banks in five cities every year. Five years later, all cities will open to foreign banks, so that foreign banks can enjoy national treatment. The openness of this commitment is very strong, even causing panic in the domestic financial sector. This was mainly because the situation of the domestic banking industry was very bad at that time, and many people were worried that the "wolf" would eat the sheep.
But I didn't quite agree with this concern at that time. Professor Bonin, the editor in chief of the Journal of Comparative Economics, and I have done a research together. We draw on the experience of countries around the world and believe that the most worrying thing for foreign banks to enter the Chinese market is not that foreign banks will overwhelm domestic banks, but that foreign banks will struggle in the domestic market. The subsequent development roughly confirmed our original guess that after China's "accession to the WTO", the proportion of foreign banks in the total assets of China's banking industry has declined. The reason is simple. Where foreign banks can go and what kind of business they can do still need to be approved by the regulatory authorities. For example, foreign banks can only go to one province to run one branch a year.
However, in any case, we believe that the government's decision to suspend the opening of capital account and focus on the opening of financial services industry is very reasonable. This is because the opening of the financial services industry is much less risky to financial stability. At that time, many people in China were worried that the entry of foreign financial institutions might confuse the domestic financial system. Bonin and I think this view is inaccurate. Foreign banks' entry into the Chinese market is equivalent to foreign direct investment in the Chinese banking industry. Only when China's financial stability, their investment can get good returns. More importantly, when foreign banks enter the Chinese market, they are subject to the supervision of the Chinese regulatory authorities. Whether the financial system can be maintained does not depend on their ownership, but on their regulatory capacity.
However, the five-year transition period of opening up the financial services industry has not yet ended, and China's balance of payments has encountered new problems. After China's accession to the WTO, its economic growth has been strong, its exports have been very active, its current account surplus has been expanding, and its foreign exchange reserves have also accumulated rapidly. Many people believe these are important evidence that the RMB is significantly undervalued. Since 2003, the international community has increasingly called for the appreciation of the RMB. The domestic public is also dissatisfied, mainly because they see a large amount of foreign exchange reserves invested in the US treasury bond market, and feel that the poor lend money to the rich, and the return from the rich is particularly low, which is unreasonable. In this way, the central bank seems to fall into a "no man inside and no man outside" situation.
In response to this wave of internal and external pressure, the Central Bank has taken three measures: first, to encourage Chinese enterprises to "go global"; Second, return to the managed floating exchange rate system; Third, we will further relax controls on cross-border capital flows. The policy of Chinese enterprises going global was first proposed at the 14th National Congress of the Communist Party of China in 1992, but it was accelerated after the Third Plenary Session of the 16th Central Committee in 2003. At first, it was mainly state-owned enterprises that invested in raw material industry overseas, and then gradually became diversified. In addition, on July 21, 2005, the Central Bank abandoned the exchange rate system pegged to the US dollar and introduced a managed floating exchange rate system with reference to a basket of currencies. From then on, the RMB began to appreciate slowly, and it lasted until August 2015.
RMB Internationalization Goes Back
Soon, the financial system of China and the world encountered a financial crisis with greater strength, longer duration and wider scope. The subprime mortgage crisis in the United States originated from the government's policy of supporting American families to own their own housing. Commercial banks issued subprime mortgages to families that failed to meet the qualification requirements, and then sold them through asset securitization. Such a high-risk product is packaged and sold all over the world, increasing the degree of information opacity. However, because of the "great relaxation" of the global economy at that time, there was no problem with subprime loans in the short term. At the beginning of 2007, the US real estate price corrected by 3%, which formed a vicious circle between the deterioration of the balance sheet, forced selling of assets and the further decline of asset prices, and finally led to a century crisis.
The Chinese government has once again taken some timely countermeasures: on the one hand, it has strengthened the management of cross-border capital flows to prevent the stability of the domestic financial system from being impacted by large capital inflows and outflows; on the other hand, it has significantly narrowed the floating range of the exchange rate from July 2008 to October 2010. But in fact, the other two policies are more concerned. First, the Chinese government announced the "four trillion" stimulus policy at the end of 2008. This policy helped stabilize the economic growth of China and even some other countries. China's GDP growth rate increased from 6.1% in the first quarter of 2009 to 10.7% in the fourth quarter. Of course, this policy has also left such sequelae as the excessive debt of local governments, the decline of capital utilization efficiency, and even the rise of asset bubbles. Second, since 2009, the central bank has bucked the trend to promote RMB internationalization. This is mainly because after the subprime crisis, the international community has doubts about the status of the US dollar as the international reserve currency. In fact, the Central Bank is following the trend to promote the process of RMB internationalization: first, actively encourage RMB settlement of cross-border trade and investment; Second, establish RMB offshore markets overseas, especially in Hong Kong, China, and issue RMB denominated assets at the same time; Third, open domestic financial markets to central banks and sovereign wealth funds and encourage them to hold RMB assets; Fourth, promote the RMB to join the IMF SDR basket. At the same time, the freedom of cross-border capital flows began to slowly increase again.
It should be said that the policy of RMB internationalization was once very successful, and the proportion of RMB in international payments and reserves rose steadily. Except for Hong Kong SAR, London, Singapore and even New York all actively strive to build the offshore market of RMB. Unexpectedly, the suspension of RMB internationalization process was triggered by the efforts to let RMB join the SDR basket. The IMF report on RMB basket entry in the first half of 2015 criticized the non marketization mechanism of the RMB central parity rate. In order to allow the IMF Board of Directors to smoothly approve RMB basket entry at the end of November, the Central Bank launched the reform of the central parity rate on August 11, 2015, mainly to strengthen the marketization component. The central parity rate in the morning is determined by three factors: the closing price of the first day Overnight changes in the global foreign exchange market and other factors.
Such a reform that should have been cheered by the market has turned into the fuse that triggered the expectation of a sharp devaluation of the RMB, which should be greatly unexpected by policymakers. But what really holds back the process of RMB internationalization should be the inflexible RMB exchange rate. Since 2005, although China has implemented a managed floating exchange rate system, the central bank has repeatedly said that it would improve the flexibility of the exchange rate, but the flexibility is always insufficient. After 2010, the economic growth continued to decline, and the current account surplus also continued to shrink. Since the second half of 2014, the market has formed an expectation of RMB depreciation. The central bank moderately lowered the RMB exchange rate while improving the central parity rate, which made the market think that the depreciation expectation was finally confirmed and triggered a round of spectacular capital outflows.
In order to stabilize the financial system, the central bank has again taken two measures: first, strengthen the management of cross-border capital flows, "expand inflow and limit outflow"; Second, use foreign exchange reserves to intervene. After about a year and a half of efforts, depreciation expectations were basically eliminated by the end of 2016. The result of strengthening the management of cross-border capital flows is that RMB internationalization has been put on the brake, and capital flows are less free. Where can we start monetary internationalization? In order to prevent the exchange rate of Hong Kong's offshore market from disturbing the expectations of the onshore market, the Central Bank even drained the liquidity of the offshore market. In response to the call of the Central Bank, some international financial institutions set up "RMB Internationalization Business Department" and some payment infrastructure had to go into hibernation for the time being.
Objectively speaking, these measures taken by the Central Bank at that time were also unavoidable and achieved the expected purpose. However, the lesson is also profound. It is flawed, at least, in the choice of reform order, to vigorously promote the internationalization of RMB before being unable to withstand the relatively flexible fluctuations of the exchange rate. This is actually a lesson from the East Asian financial crisis, that is, we should pay attention to the order of financial reform and opening up. The internationalization of RMB has to go back, which only confirms this simple principle again.
Experience and Lessons of China's Financial Opening Policy
The economic situation in 2017 was relatively stable, but some domestic financial risk factors broke out frequently, especially in the fields of shadow banking, Internet finance and local financing platforms. The government began to focus on preventing systemic financial risks, including the reform of the regulatory framework. The National Financial Work Conference held in July 2017 decided to establish the Financial Stability and Development Committee of the State Council to coordinate economic and financial policies. In order to stabilize the exchange rate, some policies to manage cross-border capital flows have also withdrawn from the market. In October, the State Council announced that it would further open up the financial services industry, increase the proportion of foreign shares, and promised that it would no longer set restrictions on foreign shares after three years.
China's reform and opening up policy has been implemented for 40 years, and the promotion of financial opening up policy has also experienced more than 20 years. If macro indicators are used to measure the effect of the financial opening policy, the achievements are still outstanding. A large amount of foreign direct investment has made an important contribution to both exports and growth. In addition, the domestic financial system is relatively stable, and the balance of payments has been relatively healthy, providing strong support for investor confidence. However, some problems of the financial opening policy are also quite obvious. The "Jingshan Report" "The Second Half of China's Financial Opening" released by the 2017 China Financial 40 Forum summarized three characteristics of China's financial opening policy: first, slow and repeated; Second, it is determined and difficult to promote; Third, policy coordination is not enough.
The experience of China's financial opening policy also provides some important experiences and lessons, which can help China better design and implement policies in the next stage, and may also be useful for other emerging market economies that are opening up.
First, the announced policies should be implemented as far as possible. In the past, we used to "talk more and do less", which may be the basic feature of "gradual reform", but more times will lose credibility in the market. When we entered the WTO, we promised to open the domestic market to foreign banks. In fact, foreign banks did not really enjoy national treatment. Over the past 13 years, we have also said that we should improve the flexibility of the exchange rate, but whenever the market fluctuates, the decision-making department is nervous, and the central bank has to take various intervention measures. Fortunately, since the end of 2016, the central bank has basically not taken conventional market intervention and has almost achieved "clean floating". However, it remains to be seen how long this policy can last.
Second, the priority of reform policies is very important. There is consensus that financial reform should focus on order, but this concept is not always well implemented. China has summed up one experience from the experience of "entering the WTO", that is, "promoting reform through opening up". However, it may not be appropriate to mechanically apply this experience from the real economy to the financial field. If the domestic reform is not done well, opening the financial door will easily lead to risks. Therefore, in practice, we should try our best to combine "promoting reform through opening up" and "assisting opening up through reform". The urgent task of our country should be to complete the interest rate marketization reform as soon as possible, and at the same time significantly improve the flexibility of the exchange rate, before we can consider the further opening of cross-border capital flows.
Third, the opening of the financial services industry can go ahead. If the broad sense of financial opening is divided into financial service industry opening and capital account opening, then the former can go faster, because the entry of foreign financial institutions can increase competition, bring new management technology, and help domestic economic growth. The opening up of the financial services industry does not involve the large inflow and outflow of capital, and is also subject to domestic supervision. In fact, the risk is relatively low. The boycott of domestic and foreign funded financial institutions has both ideological and interest factors. The problem of ideas can be convinced by making clear the reason, but the problem of interests is relatively difficult to overcome, which may require the decision-maker to make a decision from a macro perspective.
Fourth, pragmatically determine the goal of capital account opening. In the past, we used to regard full convertibility as the goal of capital account liberalization, which is actually worth further discussion. One of the reasons for the financial crisis in East Asian countries is the excessive foreign debt. After the subprime crisis, the international policy community has formed a new consensus that large inflows and outflows of short-term capital may bring greater risks. Therefore, the IMF has also begun to change its policy stance, allowing countries to adopt partial and temporary restrictions on cross-border capital flows for the purpose of maintaining financial stability or monetary policy independence. For China, it may be difficult to fully bear the consequences of full opening of capital account in the short term, and basic opening may be a more pragmatic goal.
(The author of this article is a professor of the National Development Research Institute of Peking University and the China Economic Research Center.)
