Liberalization of Capital Account with China’s Characteristics

1. Introduction Unlike other crisis-hit developing countries (Mexico, Korea, Thailand and Brazil) known by their large-scale utilization of foreign capital, China weathered the storm in 1997 safe and sound. However, some analysts said that China would have involved itself into the crisis if the Asian financial crisis came two years later. Many academic papers like Huang and Yang (1998) attribute China's survival from the crisis to the strict control of its capital account, while disregarding the phenomenon that China was no better than the crisis-hit countries in its capital and financial account. During the period between 1996 and 1998, China witnessed a big drop in its capital account, which is similar to Thailand and Korea (see Figure 1). Furthermore, it is very difficult to stop the outflow of capital even though the control is resumed. Once the country is integrating itself into the world economy, the control on its capital account will become less effective. It is worthwhile to re-study all the economic variables between China and those crisis-hit countries comparatively in order to identify those factors that help China stand not contagious during the crisis. The success of China's economic reform is unique because of its special performances. China never follows suit of other countries, no matter what approaches they may take, such as " sequencing " or " big bang ". Instead, China adapts itself to its own conditions and takes full advantage of them. Many previous studies on capital account liberalization have references of financial crises. Kaminsk and Reinhart (1999) even measure the timing between financial liberalization and crises with many developing countries in their samples. Their empirical studies imply that the financial crises (in the form of currency crisis, banking crisis, and balance-of-payment crisis) seem inevitable after liberalization of capital account. Will this pattern be true to China? This paper intends to find the characteristics of China's utilization of foreign capital by reviewing how China tided over the Asian financial crisis. Based on the findings, three approaches are put forward for China in its liberalization of capital account. First, China should make continuous efforts to introduce foreign capital with export-orientation. As long as trade balance is in surplus, foreign investors will have high credibility on China's economy and this will affect their investment behavior. Second, convertibility under the capital account should first extend to Hong Kong and then to Macao and Taiwan accordingly since the investment …