Chinese liberalisation could be ‘force for global stability', says BoE economist

China's capital account liberalisation will "dramatically increase" the country's international investment position to as much as 33% of world GDP by 2025, according to an article in the Bank of England's latest quarterly bulletin.

The Chinese authorities reaffirmed their commitment to lifting the capital controls that govern the purchase and sale of foreign and domestic financial assets in a crucial meeting last month, while the People's Bank of China (PBoC) has suggested full liberalisation could be achieved within the next decade.

Today's article, authored by BoE economist John Hooley, says the country's global financial integration "has the potential to be a force for economic growth and financial stability not just in China but also globally".

In 2011, China was responsible for 9% of all world trade and yet its international investment position – defined as the average of its external assets and external liabilities, excluding central bank reserves – was less than 3% of the world's nominal GDP.

It jumped to around 5% in 2012, and Hooley believes it will increase as the "openness gap" between China and advanced economies falls, and as the Chinese economy continues to grow at a faster rate than the world economy. Both these factors, the article said, have the potential to generate "large" capital flows.

This has the potential to create "more sustainable growth" in China. The country has previously relied on exports and investment to drive its economic growth, but is beginning to place a greater emphasis on consumption as a source of demand.

Hooley says lifting the restrictions on capital outflows will allow Chinese companies and households to diversify their savings by investing abroad. This would help to spread risk and subsequently "reduce the need for precautionary saving and hence free up income for current spending".

However, Hooley argues, capital account liberalisation can also create instability, and authorities will need to employ a mix of macro- and micro-prudential policies to mitigate any risks arising from excessive credit growth and asset price volatility.

"Which of these outcomes – more sustainable growth or a rise in instability – would dominate will depend on the accompanying policy framework," he says.

Hooley identified a host of "important benefits" that a more global integrated China will bring to the rest of the world – including greater risk-sharing, and a "more diversified and more stable" global investor base.

"A new source of global liquidity from China could lead to several beneficial effects, particularly during a period where the world's financial system is becoming increasingly fragmented and retreating into national borders," he says.

Another side effect of China's liberalisation will be the greater internationalisation of the renminbi. Hooley notes that this could reduce transaction costs and lower the risk of currency mismatches, but also has the potential to amplify the international transmission of any shocks in China.