Should emerging economies maintain an "appropriate" level of capital controls to cope with increasing volatility of international capital movements? This has become a hot topic among academics and a focus of discussion in domestic policy circles as well. In recent years,academic research has concluded that emerging markets should impose controls on capital flows under certain circumstances. Moreover,the International Monetary Fund has dropped opposition to capital control. Since 2012,domestic academics have argued over whether capital account liberalization should be accelerated,but no consensus has been reached. In the initial stages of capital account reform,the Chinese government followed a gradual and prudent approach,but after the 2008 global financial crisis,capital account liberalization was accelerated significantly in China. The speeding up in the pace of liberalization reflected a change in the Chinese government's thinking. However,the potential risks may have been underestimated. In view of the complicated international and domestic situation that the Chinese economy now encounters,the government should adhere to a more prudent,orderly and controllable approach to liberalizing the capital account. Otherwise we could be faced with a systemic financial crisis at some point in time. The government should follow a proper sequencing order in its effort to open up the capital account and speed up the construction of its macro-prudential regulatory framework. It should also vigorously promote domestic structural reforms and establish a reliable early warning system to signal potential crises and it needs adequate  management and response mechanisms.

The Paths to Capital Account Liberalization

Drawing important lessons from the experience of the Asian financial crisis of the late 1990s,the government has chosen to open the capital account in an orderly and controllable way. For instance,China has tried to open capital inflows first,followed by capital outflows. It seeks to deregulate long-term capital flows before addressing short-term capital movements. Generally,it has adopted a pilot project approach,allowing liberalized capital movements under quota systems. Once authorities have time to examine the results of their reforms,controls can be relaxed further or even eliminated.  

Before the 2008 financial crisis,China's capital account had already achieved partial liberalization. For cross-border direct investments,there had been substantial liberalization in regard to inbound foreign direct investments and outbound direct investments. These capital movements were permitted as long as they complied with relevant industry regulations,had gone through a verification process and had received required approvals.   Authorities had also implemented two-way quota management for cross-border investments in securities. Foreign portfolio investment in China was limited by quota restrictions under the Qualified Foreign Institutional Investor (QFII) program,while outbound portfolio investment was managed under the Qualified Domestic Institutional Investor (QDII) program. Through this quota management system,the Chinese government maintained a controlled liberalization of its regime for managing cross-border securities investments. Lastly,the government adopted a classified management method on other cross-border investments (fund flows related to bonds and borrowings).