On International Short-Term Capital Movements and China's Monetary Policy Independence: An Empirical Analysis
Pinghai, Li, Wei, Lu, Haijian, Li, China: An International Journal
Since 1996, the scale of capital flight from China has constantly increased. Between 1998 and 2003, capital flew out of China at an even greater volume than the international capital influxes in the forms of foreign direct investment (FDI) and foreign debts. From 2003 onwards, large amounts of hot money flew into China, concealing the scale of capital flight from China. This not only enhanced the demand for Chinese money supply and stimulated asset price bubbles in China's stock and real estate markets, but potentially risked triggering a financial crisis. When the short-term international capital movement eventually changes its direction, China will find itself in a trap similar to that which the Southeast Asian countries experienced over a decade ago.
It is not considered controversial that some fractions of short-term international capital movements can be shown on the balance of payments (BOP) statement of a country. Scholars disagree mainly on how to measure the scale of implicit short-term international capital movements. Due to the different measurements, various pertinent approaches have been developed one after another, such as the BOP accounts approach, residual method, Morgan's approach, Cline's approach, etc.
Chari and Kehoe (1) constructed a model for hot money, stating that a herding effect comes into being for short-term international capital movements, due to information friction and credit delay. Calvo, Leiderman and Reinhart (2) pointed out that due to an influx of short-term international capital that causes the inevitable rise of the general price level in host country, the domestic interest rates must be raised to offset the adverse effects of the influx. But Kumhof (3) proves that a better way for the host country to tackle the inflation effects caused by an influx of short-term international capital is to reduce, instead of raise, the domestic interest rates because increasing interest rates could in turn adversely impact the domestic economy.
Many Chinese scholars have conducted research on the impact of international capital movements on China's economy. Unfortunately, most of their work is too general and does not differentiate between long-term and short-term international capital movements.
On the one hand, debate in China about the efficiency of monetary policy has led to research on how the features of an opening-up economy impact monetary supply and form interest rate mechanisms. (4) On the other hand, debate about the reform of China's exchange rate system results in research on whether greater flexibility in the renminbi (RMB) exchange rate may or may not strengthen China's monetary independence. (5)
This article attempts to combine the traditional method with investors' motivations in the analysis. Thus, short-term international capital movements include not only the components reflected in the BOP account, but also implicit and illegal capital movements.
CHANNELS OF INTERNATIONAL CAPITAL MOVEMENT IN CHINA
Short-Term International Capital Movements in the Current Account of China's BOP
Since 1996, the Chinese currency has been convertible under the current account, making it easier for the influx of international capital under legal disguises to avoid official control. As shown in Table 1, income receipts fell sharply during the Asian financial crisis but soared in 2002 when the RMB was expected to appreciate in value.
In 2004, the net outflow of investment returns fell to only USD41.55 billion from USD186.19 billion in 2001. For the first time, the investment returns showed a net influx, reflecting a strong correlation between investment returns and expectation of the RMB fluctuation in value. It was due to the strong expectation of a RMB appreciation between 2001 and 2008 that the net outflow of investment returns decreased sharply and turned positive from 2005 onwards. Furthermore, the net capital influx under current transfers increased steadily and even more from 2001, showing possibilities of arbitrage transactions with international capital movements via current transfers such as donations. …