Readthe article from THE ECONOMIST re: China's Capital Controls

a) Is China a net saver or net investor?

b) Are China's interest rates higher or lower than in the U.S.? What can you say about China's "real interest rates"?

c) Why is China an attractive destination for "foreign direct investment"? (clarify your understanding of FDI vs. other types of capital flows)

UIOI'IOUS and arduous ls China's great wall of capital controls keeping money in or out? Aug 1_nt_h_ 29.13.! From the print edition . r. mm AT ITS recent mid-year meeting, China's State Administration of Foreign Exchange (SAFE), which helps to regulate the flow of capital across the country's borders, weighed the task ahead. China is committed to making its currency, the yuan, fully convertible, relaxing the controls that keep foreign money out and domestic money in. A plan is expected this year. At its meeting, SAFE concluded that the next phase of foreign-exchange management will be \"glorious and arduous\". It will certainly be the latter. China rst promised to make the yuan fully convertible in 1993, setting the end of that decade as a deadline. Back then the Asian financial crisis helped undermine the case for quick and early capital-account liberalisation. But China's peculiarities have also reduced the sense of urgency. Most emerging economies relaxed capital controls because they wanted to invite money in. By importing foreign capital, poor countries could invest more than they themselves could afford to save. But China already saves more than it investsand invests more than it probably should. In China the case for liberalisation is more subtle. In a report on China's economy. published last month, the International Monetary Fund (IMF) argued that a gradual liberalisation of capital flows would improve the efficiency of investment (as opposed to the quantity). It did not spell out its reasoning. But reasons are not hard to find. As outsiders, foreigners are free to invest their money wherever they see fit, unencumbered by the broader political obligations that weigh on state-owned lenders. Relaxing capital controls would also allow Chinese savers to diversify their assets, taking the heat out of China's boiling property market. If households were allowed to invest more easily abroad, they would no longer see Chinese property as their only alternative to bank deposits paying capped interest rates and a stockmarket plagued by scams and speculation. This argument raises interesting questions. Does China have more to gain from investment by the rest of the world or investment in the rest of the world? And if China's foreign-exchange controls were lifted, would capital ow in or out? A case can be made for either outcome. China is (still) growing faster than most other countries. Although interest rates on deposits are capped by the government, they are higher than rates in America or Japan. And its exchange rate is still rising, reaching 6.12 yuan to the dollar this week, the strongest rate in 19 years. Sure enough, in the rst quarter of 2013, short-term capital surged into China: the net inow of investment, excluding foreign direct investment, amounted to $58.2 billion. And yet many China sceptics make the opposite case. They believe that households nervous about China's slowing growth and capricious government would seize the chance to take their money abroad. Individuals are already allowed to take out $50,000 a year, and many nd ways round that limit. Pessimists believe an even bigger pool of money would pour out of China if the floodgates were opened. As if to prove this point, as China's growth slowed in the second quarter of this year, short-term capital changed direction, owing out of the country. In their report, the lMF's economists offer their own view on what would happen if China relaxed its capital controls. They concentrate on \"portfolio" investment: purchases of purely nancial assets, such as bonds and shares, ignoring longer-term direct investment or bank lending. They conclude that the flow of capital across borders would expand dramatically in both directions. But portfolio outows would dominate. Foreigners would buy Chinese securities worth a minimum of 2% of China's GDP and a maximum of 10%, the IMF authors estimate, adding greatly to China's foreign liabilities. Chinese residents, on the other hand, would acquire foreign assets worth 15-25% of the country's GDP. The combination of these criss-crossing ows would add securities worth up to 18% of GDP to China's net foreign assets (see left-hand chart). Renminbi or Renmaxbi In response to such a big outflow of capital, the yuan would surely fall. Or would it? The IMF's economists believe the yuan is still \"moderately undervalued\". Can these two conclusions be reconciled? Their study of capital ows concentrates on portfolio investment, but the fate of the currency would also depend on other kinds of money movements. The biggest outow of capital in |China today passes through the central bank. It buys dollars (and other foreign currencies) to relieve upward pressure on the yuanpressure that stems from China's big trade surplus and the direct investment it attracts. If capital controls were lifted, and private capital owed outwards, this pressure would ease. The central bank could stop accumulating foreign-exchange reserves at such a pace. In short, if China's firms and households buy more foreign assets, its central bank could buy fewer. That would be good news. China's private investors would probably buy more rewarding assets than its central bank, which has mostly limited itself to safe, low-yielding securities. Last year China earned less on its enormous assets abroad (worth over $5 trillion) than foreign investors earned on their smaller holdings in the country (worth less than $3.5 trillion: see right-hand chart). Its international investment income was minus $57.4 billion. By the time China's capital account is fully open, its foreign-exchange reserves will account for less than 40% of its assets abroad, according to a 2012 study by the Hong Kong Institute for Monetary Research. The rest will be more lucrative direct investments and privately held securities. China will at last earn more on its foreign assets than it pays on its liabilities. In 2020 the institute's economists reckon, its net investment income will amount to about $250 billiona not inglorious result