The process of Mainland China's financial liberalisation ground to a halt in 2015-2017 after experiencing a cluster of episodes of financial turmoil following the exchange rate reform of August 2015. The authorities had to halt the progress of financial liberalisation and shift their policy priority to maintaining financial stability. In some areas, the authorities even rolled back some reforms in a bid to curb systemic risks.
After a few years of adjustment, the authorities now seem to be ready to press ahead with their agenda of financial liberalisation again. The authorities’ renewed interest in financial liberalisation is broad-based, covering several areas including interest rate liberalisation, exchange rate flexibility, capital account convertibility and domestic financial market opening.
A confluence of factors has led to the authorities deciding to reinvigorate their liberalising agenda for the financial sector at this point.
First, a new regulatory framework has been created to address the long-standing problem of the lack of coordination among different regulators and the central bank. Second, Mainland China’s rebounded growth in 2017, synchronized with other major economies, has effectively strengthened investors’ confidence. Above all, the authorities are well aware of the point that structural reforms in the financial sector are the best solution to systemic risks. Last, some increasing pressure from the external environment has also prompted the authorities to make new moves, chief among which is the escalating trade tension with the United States.
In addition, it is imperative for the Mainland to continue to advance financial liberalisation before the International Monetary Fund’s next periodical review of the Special Drawing Rights basket, scheduled to take place in 2021.
This round of financial liberalisation reform includes the following perspectives:
First, complete interest rate liberalisation has been achieved. Mainland China nominally wrapped up its decades-long process of interest rate liberalisation in October 2015 as the People’s Bank of China (PBoC) announced the lifting of deposit rate caps and gave banks full liberty to determine the interest rates they offer to their borrowers and depositors.
The PBoC also has the right to set the benchmark interest rate to guide the market rate. Thus, in April 2018, the PBoC allowed banks to offer deposit rates to their clients on a business basis. This marks the real completion of interest rate liberalisation in the Mainland. Meanwhile, the PBoC started to construct a new monetary policy framework – the corridor system – to replace the old policy framework featuring the adjustments of banks’ benchmark lending and deposit rates.
Second, exchange rate liberalisation seems to be back on the authorities’ agenda. Exchange rate liberalisation has been suspended for some time after a failed RMB exchange rate reform on August 11, 2015. However, after Mainland China’s economy successfully engineered a recovery in 2017, together with the depreciation of the U.S. dollar, the pressure on currency depreciation has largely been alleviated. The authorities have accordingly taken out the counter-cycle factors in determining the daily mid-price of the RMB since early 2018.
We forecast that the final stage of the exchange rate liberalisation will be the “Clean Float,” which is likely to happen after the domestic financial system completes its deleveraging and regains its healthiness. That being said, the authorities could allow the exchange rate to float before 2020.
Third, capital account opening also saw some new developments. Regarding the stock market opening-up, preparatory work for the Shanghai-London Stock Connect is proceeding as desired, which is expected to be launched this year. The PBoC increased the daily quota by three times from 1 May, for the Shanghai-Hong Kong and Shenzhen-Hong Kong stock connects.
The expansion of the daily limit in the stock connect programmes particularly caters to the demands of the Chinese A-share inclusion by MSCI, a global provider of indices and analysis. MSCI announced that it would include 234 China A Large Cap shares in the MSCI Emerging Markets Index starting this month.
Together with the expansion of stock connect programmes, the authorities have also increased the quota for Qualified Foreign Institutional Investors (QFII), Qualified Domestic Institutional Investors (QDII) and Renminbi Qualified Foreign Institutional Investors (RQFII).
Finally, more financial market opening measures have been announced. Amid pressure from the U.S. trade war threat, President Xi Jinping, in his speech at the 17th Boao Forum for Asia in April, announced plans to further open the Mainland’s economy. During the forum, the newly appointed PBoC governor Yi Gang gave the details and timetable of the opening-up policies for the financial sector. These measures include:
(i) Removing the foreign ownership cap for banks and asset management companies, treating domestic and foreign capital equally;
(ii) Lifting the foreign ownership cap to 51% for securities companies, fund managers, futures companies and life insurers, and removing the cap after three years;
(iii) No longer requiring joint-funded securities companies to have at least one local securities company as a shareholder;
(iv) Allowing eligible foreign investors to provide insurance agent and loss adjuster services; and
(v) Lifting restrictions on the business scope of foreign-invested insurance brokerage companies, treating them as equals of domestic companies, etc.
Although the restart of China’s financial liberalisation has sent an encouraging signal, the market still has concerns about whether the new momentum is sustainable enough. We have a more optimistic view in this respect. This time should be different, because both external pressure and domestic need will force the authorities to advance financial liberalisation and make the real breakthroughs.
Meanwhile, the Mainland authorities have also felt the urgency to honour their promise to the World Trade Organization and open the country’s financial market so as to create a benign external environment. From a strategic perspective, it is in Mainland China’s own interest to accelerate financial market opening to win over more friends in defence of the U.S. attack on the country’s export sector.