China to allow foreign direct investment in RMB

By Liang Jie (People's Daily Overseas Edition)

17:06, August 26, 2011

Edited and Translated by People's Daily Online

Foreign investors will be able to make direct investments in China with RMB obtained legally from overseas, according to the draft guidelines on RMB foreign direct investment (FDI) recently issued by the Ministry of Commerce. 

The ministry is currently soliciting public feedback on the new rules. This regulatory framework for cross-border RMB FDI will be officially launched contingent on smooth pilot runs. Some insiders believe that this guideline will provide specific rules to follow in the backflow of RMB raised overseas, which will be another major step for the country's efforts to internationalize the RMB and open its capital market. 

RMB internationalization to be accelerated

This move shows the central government's determination to accelerate the internationalization of the RMB.

"China launched the pilot FDI in RMB mainly for two purposes. The first purpose is to promote RMB internationalization, and the other is to coordinate with cross-border RMB trade settlements and the issuance of offshore RMB-denominated bonds and shares," said Dong Dengxin, professor in Wuhan Science and Technology University. "This will make it easier for foreign-funded enterprises in China to remit RMB-denominated profits, transfer shares, reduce capital investment, liquidate assets and recoup capital investment, thereby reducing the currency risks facing them." 

Experts believe that expanding the scope of cross-border RMB settlements will improve and perfect the RMB exchange rate formation mechanism. The significance is that once a RMB reflowing mechanism is established, it will expand channels for overseas-acquired RMB funds to flow back into the country. It is a great progress in the course of RMB internationalization and will lay the foundation for the full convertibility of RMB capital accounts. 

Paying special attention to "hot money" risks

China should urgently accelerate the process of interest rate marketization and RMB internationalization. Dong believes that the route to realizing interest rate marketization is: one, establishing a multi-layer capital market and developing the direct financing; two, establishing a bank deposit insurance system and allowing banks to go bankrupt like enterprises. The route to realizing the RMB internationalization is: first, adopting the cross-border RMB settlement, then, issuing overseas RMB bonds and stocks, and finally realizing the direct cross-border RMB investment. 

In other words, the RMB will change from a regional cross-border settlement currency to a regional cross-border investment currency. It is the essential route for the RMB to go from the current account convertibility to capital account convertibility and also an essential route for the RMB to change from a regional cross-border currency to a global cross-border currency ultimately.

Insiders notably reminded that China should be particularly alert to the "hot money" risk when opening the capital account. As China is committed to promoting RMB Internationalization, the eased capital account regulation in certain areas will likely lower the costs of the inflows of short-term international capital into China. Following the gradual opening of the capital account, "hot money" is more likely to flow into China through capital channels than trade channels in the future. 

Experts said that what an open economy fears is not the inflows and outflows of capital but the uncertainties in its inflows and outflows, so that China should prevent the risks and impact brought about by intensive capital inflows. The establishment of the RMB backflow channels means the further opening of China's capital account. 

The RMB had better flow out and be used in other countries and regions rather than flow back. However, the RMB is not strong enough to achieve this goal. Therefore, China should prevent a huge amount of RMB from flowing back. Thus, China must ensure whether the backflow capital is actually invested in the real economy.

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