Capital Account Liberalization and Capital Movement in China

Capital Account Liberalization and Capital Movement in China

Badar Alam Iqbal, Nida Rahman, Mohd Nayyer Rahman
Copyright: © 2021 |Pages: 16
DOI: 10.4018/JCAD.2021010103
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Capital account liberalization has always been at the core of economic policymaking. China is a country which has chosen to go gradual in opening up the capital account. The present research seeks to manoeuvre aspects of capital account liberalization for the Chinese economy. An empirical investigation is run for ascertaining the particular influence capital controls has had on foreign direct investment in China which has outpaced other capital flows in the past decades. The model applied involves foreign direct investment inflows as the dependent variable while four variables are independent. The stationarity of the univariate series is checked with the use of Augmented Dicky Fuller test. The study concludes with theoretical understanding that full liberalization of the current account in China has overall benefited the economy. The outcome of the study suggests that there is no significant bearing of current account liberalization on foreign direct inflows.
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1. Introduction

Globalization has generated enormous gains for the developing world as is displayed in their ameliorating economic growth and wide connectivity with the developed regions of the world economy. Macro-economic data for indicators like Gross Domestic Product, Investment, Productivity, etc. entails the success of globalisation and integration into the world economy. The emerging market economies of present times are moving undeterred, and credited to the phenomenon of globalisation. More specifically, several aspects of globalisation like trade liberalization and capital flight have added to the performance of emerging market countries. The addition to global GDP by emerging market economies has over the period bloomed extravagantly. However, over time unprecedented economic events have charred the belief of globalization being a generator of gains only. The opening up of financial and international accounts of economies have been associated by many to the brewing of economic crisis and downturns in progress (Demirguc-Kunt & Detragiache, 1998; Easterly et al., 1999; Stiglitz, 2000). Past economic misfortunes in the form of Mexican Financial Crisis of 1994, Asian Financial Crisis of 1997 and the Global Financial Crisis of 2008 had, as believed by many, in its backdrop capital controls undoing as a prominent reason. The series of economic downturns in the form of currency and financial crisis gave impetus to the belief of Capital Account Liberalization bringing these economic mishaps. To counter the accompaniment of economic crashes as the capital account unleashes, many countries especially the developing and emerging market economies started erecting controls on their capital account dealings. Much of the capital controls emerged out of fear of impediment-free capital movements carrying distortions with them (Sulimierska, 2008). Nevertheless, another perspective holds that limiting capital movements is itself a distortion (Eichengreen, 2001).

China’s venture into the policy regarding Capital Account Liberalization (CAL) has been a restrained yet progressive one. While Foreign Direct Investment movements have witnessed an opening for the Chinese economy, Portfolio flows remain chained to a considerable extent. The reason often brought into discussion for this behaviour is the volatility concern guiding China to propel one kind of capital flow while treading cautiously in its dealing on another kind of capital. The issue of volatility characteristic of capital flows has been dealt at great length by a huge number of studies. The dominant view about the volatile character of capital flows reckons Foreign Direct Investment to be less fragile to extraneous factors while Portfolio flows stand as the more volatile one. The less volatile feature of Foreign Direct Investment and a long term source of finance has been sworn in studies led by Dadush et al., 1994; World Bank, 1999; Hausman & Fernandez-Arias, 2000; Iqbal, Rahman & Turay, 2017; and Rahman & Rahman, 2018. The surge in Foreign Direct Investment flows to China has been a dominating phenomenon in the overall capital flows pouring into the economy. The period post China’s embrace of market reforms in the late 1970s saw a great incoming of capital specifically taking the form of Foreign Direct Investment. Portfolio Investment remained behind hand. However, the situation over time has improved with Portfolio flows climbing modestly.

The pacing up of Portfolio flows and the turn up in Foreign Direct Investment flows has a connection with the easing in capital controls. As the Chinese economy went on relaxing rules regarding capital flows, the numbers kept on running. Major relaxations in the capital account came up in 1984 where China opened its coastal cities for the embrace of foreign capital. Figure 1 is a representation of the expansion in Foreign Direct Investment and Foreign Portfolio Investment over the period. It can be made out from the figure that the gap between Foreign Direct Investment and Total Portfolio Investment inflows is contracting in recent years. The reasons might emerge from China's furthering of liberalisation in the Portfolio category of investments too. This reverberates in figure 2 also where the gap between Foreign Direct Investment flows as a share of GDP and Portfolio Investment as a share of GDP are seen to be close to convergence in the latest years. The figure tells us that the greatest divide has been in the years following 1992. The dip in portfolio investment after 1997 corroborates with the pessimism regarding capital account liberalization post the Asian Financial Crisis, 1997.

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