Journal Issue
Share
Article

People’s Republic of China: 2011 Spillover Report—Selected Issues

Author(s):
International Monetary Fund
Published Date:
July 2011
Share
  • ShareShare
Show Summary Details

IX. CHINA’S CLOSED CAPITAL ACCOUNT AND CAPITAL FLOWS TO EMERGING MARKETS1

There is a view that China’s closed capital account has exacerbated the recent surge of capital flows to other emerging markets (EMs). It is hypothesized that the inability of investors to have direct exposures to portfolio investment in China led them to look for substitutes in other EMs, which in turn contributed to the inflows elsewhere. While this is plausible, the evidence below is ambiguous.

1. Closed capital account. China’s capital account is tightly controlled and remains largely closed to portfolio flows. The controls are comprehensive, effective, and binding in both directions. Thus, portfolio flows account for a small fraction of capital flows. This is in contrast to other EMs with open capital accounts, where portfolio flows are of greater importance, as evidenced in various episodes of surging capital flows.

2. Capital inflows. China is the single largest recipient of capital inflows among all EMs. During the period 2009Q3–2010Q2, 29 percent of the inflows to EMs ended up in China, while China’s GDP is about 31 percent of the same group of countries. While the aggregate inflows to China do not appear to be distinctly small, it should be noted that in other large countries their share of flows is larger than their share of GDP.

Gross Capital Inflows by Region

Source: IMF IFS.

3. Hong Kong SAR listed firms. Investors could gain direct exposures to Chinese portfolio assets by buying Chinese stocks listed in Hong Kong SAR. H-share (mainland companies listed in Hong Kong SAR) and red-chip (companies with main business in the mainland) stocks account for around 50 percent of market capitalization of HKSE (about US$2.7 trillion). If capital flows were being diverted from China, Hong Kong SAR would be a natural place to receive such flows and one would expect to see large inflows and a surge in equity prices in Hong Kong SAR under its linked exchange rate regime. However, there has been no evidence of large inflows into the Hong Kong SAR stock market (even some outflows in the most recent quarters). In addition, the performance of the Hong Kong SAR stock market is decisively in the middle of the pack compared to regional peers.

Hong Kong SAR: Gross Portfolio Inflows

Selected Markets: Stock Market Performance

(Index, Jan 2009 = 100)

4. Regression analysis. Empirical analysis of how overall flows and the composition of flows would change as a result of an opening of China’s capital account is hindered by the lack of variation in the data on the degree of openness over time of China’s capital account. Such analyses would need to rely on differences in the openness across other EMs’ capital accounts to make inferences, but given China’s size and importance it is difficult to draw firm conclusions for China from such an exercise. In a regression that includes pull and push factors of capital flows as well as a measure of capital account openness, a country’s own capital account openness is found to have a significant impact on capital flows into itself (details about the regression are provided in Recent Experiences in Managing Capital Inflows—Cross-Cutting Themes and Possible Policy Framework). But there is no clear evidence that partner countries’ capital account openness matters for its capital inflows, or alternatively stated that the closed capital account of one country contributed to additional inflows to other countries (Table 1).

Table 1.Determinants of Gross Capital Inflows
AllDebtEquityDirect

Investment
Other
US 10-year yield-0.0972***-0.213**-0.141-0.145***-0.010
VIX (Log)-0.250***0.005-0.611***-0.066-0.100
Trade openness0.318-0.556-0.6220.1030.308
Inflation-0.000235*-0.000170*-0.000282-0.000227***0.0000733
Growth0.0397***0.0505*0.0595***0.0330***0.0395***
Average Size (Log GDP)0.1280.307-0.4010.2160.304**
Capital Account Openess0.547***0.719*0.809*0.2080.783***
Partner’s KA Openess1.265***0.9060.7852.291***0.646**
Constant5.220***3.518**7.066***3.349***3.129***
Country dummiesYesYesYesYesYes
Time dummiesNoNoNoNoNo
Observations27911444151431452173
Notes: The table presents panel fixed-effects regressions on factors affecting gross capital inflows and their composition over 48 emerging market economies between 1990Q1 and 2010Q2. Dependent variables are the log level of total inflows and their different components. Trade openness is the sum of exports and imports divided by GDP and average size proxied by the logarithm of average GDP in the first and the second decade of the sample. ***, ** & * denote statistical significance at the 1%, 5% and 10% level of confidence.
Notes: The table presents panel fixed-effects regressions on factors affecting gross capital inflows and their composition over 48 emerging market economies between 1990Q1 and 2010Q2. Dependent variables are the log level of total inflows and their different components. Trade openness is the sum of exports and imports divided by GDP and average size proxied by the logarithm of average GDP in the first and the second decade of the sample. ***, ** & * denote statistical significance at the 1%, 5% and 10% level of confidence.

5. Further results. The regressions also suggest that additional portfolio inflows into China may not be large were China to open its capital account. A standard gravity equation using CPIS data suggests that multiple pull and push factors could affect portfolio investments between any pair of countries (Table 2). Financial openness, as measured by the Chinn-Ito index, is only marginally significant after controlling for other factors. Quantitatively, portfolio investment in Chinese equities, where capital account openness appears to matter most, would be about 30 percent higher than the current level if China’s capital account were as open as that of Brazil.

Table 2.Determinants of Bilateral Invesments
DebtEquityBIS bank claims
Log GDP0.733***1.128***0.682***
Log GDP per capita0.238**0.463***0.131
Log distance-0.203*-0.385***-0.573***
Log exports from recipient0.02240.0681***0.202***
Measure of market depth 1/0.453***0.300***0.410***
Time difference-0.141***-0.01580.0441
Chinn-Ito financial openness measure 2/0.0920.106**-0.0901*
Common legal system0.447***0.261**0.230*
Common currency0.910***0.328*0.0497
Common language0.729***0.713***0.627***
Bilateral real exchange rate volatility-0.153**-0.001580.0255
EUREM dummy-1.170***-0.688***-0.634***
Western Hem EM dummy-0.939***-0.104-0.092
Asian EM dummy-1.092***1.068***-0.497
Other EM dummy-1.632***-0.2-0.955***
Financial center dummy0.1561.449***1.497***
Constant4.542***0.4126.135***
Observations7421023911
R-squared0.7860.8020.744
Note: ***, ** & * denote statistical significance at the 1%, 5% and 10% level of confidence.

Measures of market depth are: Total domestic and international debt securities to GDP for debt regression, stock market capitalization to GDP for equity regression and banking system’s private sector credit to GDP for the BIS claims regression.

Chinn-Ito financial openness measure is derived from the IMF’s AREAER. We use the latest indices from 2008.

Note: ***, ** & * denote statistical significance at the 1%, 5% and 10% level of confidence.

Measures of market depth are: Total domestic and international debt securities to GDP for debt regression, stock market capitalization to GDP for equity regression and banking system’s private sector credit to GDP for the BIS claims regression.

Chinn-Ito financial openness measure is derived from the IMF’s AREAER. We use the latest indices from 2008.

6. Caveats. The above tests suffer from low power. Therefore, caution is needed in interpreting the results (since, among other things, currency undervaluation and financial repression would be expected to shift asset allocations). China is not an average EM, given its robust growth and size. The regressions results reflect experiences from average EMs, and it is unlikely that an opening of China’s capital account would be seen as an average EM opening its capital account. General equilibrium effects of such an event are not captured by the analysis above but may well exist in reality.

Prepared by Kai Guo (SPR) with helpful inputs from Yanliang Miao (SPR) and Mali Chivakul (SPR).

Other Resources Citing This Publication