Should China relax capital controls?

CHINA FINANCIAL - In Brief 02 Dec 2015 by Michael Pettis

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But here’s another thought. SDR membership may actually hamper Beijing's ability to constrain capital flows because now that they have taken the seat they’ve always wanted, at the big boy’s table, they can’t really go back to tossing pieces of bread at the other kids. Beijing is going to have to show that China is a responsible member of the global elite, and for better or worse, being “responsible” seems to mean refraining from intervening in the capital account. It may be, then, that SDR membership is nothing more than a kind of stealth process of inexorable capital account liberalization, and I am pretty sure that at least some reformist policymakers see it very explicitly this way. This means that over the next few years we are likely to see Beijing lose far more control over its financial system than they or we might have expected. While free capital flows are arguably good for healthy developing countries because they accommodate and even encourage a better capital allocation process (and I say "arguably" because I am not sure I believe it), I think I could easily make the case, a conceptual case just as easily as an empirical case, that free capital flows are not good for developing countries in which debt levels are high enough to distort management and investment policies, or highly enough inverted to do the same thing. Free capital flows are also likely to be risky for countries whose balance sheets are highly mismatched and are kept from being very fragile only because government credibility keeps the balance sheets from unwinding disruptively. China, I am afraid, is on the wrong side of all three of these qualities. Beijing still has high credibility, but t...