The Roadmap For Capital Account Liberalization In Developing Countries With Special Reference To China

Under the background of RMB internationalization,capital account liberalization is inevitable for Chinese government to some extent.In order to improve RMB's status as means of exchange,unit of account,and store of value,China needs to gradually remove both direct and indirect restrictions on exchange and transactions of RMB.However,past experiences show that the opening of capital account has always preceded the international use of a currency,rather than the other way round.Also,capital account liberalization may pose risks especially for developing countries as both real-world experiences and empirical studies tell us.As a matter of fact,the better performing countries in the wave of financial globalization-such as China-were not the countries that radically opened their capital account.The "impossible trinity"suggests that a country with fixed exchange rate would face the risk of losing independent monetary policies to cope with internal and external changes,were it to have an unregulated capital account.In addition,capital account liberalization might be linked with systemic banking crises through the moral hazard problem and the impacts from foreign banks.However,previous studies tend not to distinguish between different kinds of capital flows under the name of capital account liberalization as there are 13 categories of transactions according to IMF's definition.Scholars tend to treat capital account openness as a whole by using a single indicator,no matter de jure or de facto.Neo-classicalism treats different categories of capital equally,based on which advocates of financial globalization push for rapid and deep integration in the world economy.But it will only add to the unbalanced relationship between developing and developed countries,and cannot give too much useful information for designing the roadmap of capital account liberalization.This thesis therefore argues that capital is not homogeneous,short-term capital differs from long-term capital just as industrial capital is different from financial capital.Based on the classification of International capital flows,the opening of capital account includes mainly three fields for most developing countries,namely,foreign direct investment,foreign loans that local banks borrow from foreign banks or domestic companies borrow directly from oversea institutions,and the short-term capital flows in the form of security investment.Unlike foreign direct investment that builds a lasting relationship between investors and real economy in the host country,short-term foreign debt and speculative capital are far more unstable and will lead to more fluctuations.The former can cause the problem of currency mismatch,while the latter adds to the volatility of financial market as it focuses solely on short term fluctuations in the market value of a tradable financial instrument.As financial system is largely bank-based and the majority of capital flow enters the banking system in developing countries first,this thesis therefore chooses the stability of banking system as the dependent variable and hypothesizes that foreign direct investment,one kind of long-term capital,is not significantly or negatively correlated with bank nonperforming loans ratio,one representative indicator of systemic banking instability,while short-term external debt compared with total foreign reserves and speculative capital,two kinds of short-term capital,are positively correlated with bank nonperforming loans ratio.Based on the fixed effects regression results of the panel data including 123 Low-and Middle-Income Countries from 1997 to 2015 from International Debt Statistics published by the World Bank,the hypotheses are generally approved.In addition,the t-test that examines whether there are significant differences between these three kinds of capital before and after banking crises from 1970 to 2011 shows the same results.Therefore,developing countries should pay special attention to short-term debt level and speculative capital during capital account liberalization.Combined with the general framework of discussion and the specific circumstances of China,I suggest Chinese government removing restrictions on long-term and institutional transactions first,reforming managed arrangements of exchange rate,and encouraging enterprises to go global,strengthening co-operations with strategic partners.