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The Temptation of China’s Capital Account

BEIJING – Despite fluctuations, China’s overall economic growth has been stable over the last three decades, owing not only to the economy’s strong fundamentals, but also to the government’s successful management of cross-border capital flows.

Capital controls enabled China to emerge from the Asian financial crisis of 1997-1998 largely unscathed, even though its financial system was at least as fragile as those of the affected countries. The Asian financial crisis persuaded China’s leaders to shelve plans, launched in 1994, to liberalize the capital account.

In 2002, China reinitiated liberalization efforts, lifting restrictions on Chinese enterprises’ ability to open foreign-currency bank accounts, and allowing residents both to open foreign-currency accounts and to convert the renminbi equivalent of $50,000 annually into foreign currencies. The authorities also introduced the “qualified domestic institutional investors” (QDII) program to enable residents to invest in foreign assets – one of many initiatives aimed at easing upward pressure on the renminbi’s exchange rate by encouraging capital outflows. At the same time, the “qualified foreign institutional investors” (QFII) scheme allowed licensed foreign entities to invest in domestic capital markets.

In early 2012, the People’s Bank of China (PBOC) released a report calling for policymakers to take advantage of a “strategic opportunity” to accelerate capital-account liberalization. Shortly after the release, QFII quotas were relaxed significantly.