Opening-up key priority in ongoing financial reforms

Regulators are determined to accelerate financial opening-up amid attempts to boost the value of yuan-denominated assets and attract offshore funds by removing long-existing cross-border funding obstacles.

As the country's top-level policymakers have proposed a new development pattern featuring "dual circulation"－which takes the domestic market as its mainstay, with domestic and foreign markets connecting and supporting each other－financial opening-up and structural reforms will be further promoted to support the development strategy, experts said.

Regulators recently targeted a further opening of the country's 109 trillion yuan ($16 trillion) bond market, the world's second largest. Earlier this month, the central bank and the regulators of the securities and foreign exchange sectors jointly issued a set of new rules that allow foreign institutional investors to directly enter the onshore bond exchange market, or invest through Bond Connect programs.

It marks the first time that foreign investors are able to purchase exchange-traded bonds in China. Previously, regulators only approved overseas funds that were injected into the interbank bond market, a reform that began a decade ago.

Fang Xinghai, vice-chairman of the China Securities Regulatory Commission, said earlier this month that China will soon release revised policies for foreign investors injecting capital into the onshore stock and bond markets, and broaden connect programs between onshore and offshore markets.

These new measures will encourage foreign investors to increase their holdings of yuan-denominated financial assets, Fang said.

The CSRC said that in the first eight months of this year, net inflows of foreign capital stood at 126.5 billion yuan through stock and bond connect programs. In July alone, foreign institutions increased investment in treasuries and bonds issued by policy banks to 146.26 billion yuan, a record high.

Foreign investors held 2.46 trillion yuan of Chinese bonds onshore at the end of August, up by 5.03 percent compared with July. This is the 21st consecutive month that foreign institutional investors increased their bond purchases, the central bank said.

This will encourage Chinese financial regulators to further expand financial products, including exchange-traded funds, commodities futures products and risk management instruments for foreign institutions, Fang said.

From 2015 to 2017, foreign investors mainly used the qualified foreign institutional investor platform to inject funds into the bond market, but the investment scale was limited by an annual quota and complicated administrative approval procedures, analysts said.

Last year, the People's Bank of China, the central bank, announced a removal of the ceiling on quotas for foreign investors to buy stocks and bonds under the QFII scheme. Later, the same policy was offered for the yuan-denominated version, or the renminbi qualified foreign institutional investor policy.

Economists said the proportion of bonds held by foreign investors relies heavily on opening-up measures in the capital market.

"If capital can flow cross-border more freely, China's bond market will attract more foreign funds, as now the interest rate-premium between the renminbi and the US dollar has been expanded to a record high level," said Ming Ming, a senior analyst with CITIC Securities.

Promoting the internationalization of the yuan would be another key measure, which requires expanding the currency's usage in cross-border trade, investment and commodity transactions through currency swaps, foreign aid and external concession loans, said Zhang Xiaohui, former assistant to the central bank governor.

Zhang said facilitating the cross-border payment infrastructure to improve the efficiency of yuan clearing and settlement can also help Chinese companies grow in foreign markets. That is an important part of the "external circulation" of the dual circulation development model.

Recently, financial regulators and scholars refocused on the issue of opening the nation's capital account, as the world's second largest economy has quickly rebounded from the economic contraction in the first quarter, which was hit by COVID-19. The currency showed a strong momentum of appreciation against the US dollar, and the financial sector could use this "time window" to further integrate into the world's financial system.

"(Capital account opening) is an unavoidable choice for China, no matter what kind of difficulties we will encounter over the short term," said Huang Yiping, deputy dean of the National School of Development at Peking University, who is also a former member of the PBOC's monetary policy committee.

Huang said taking prudential macro-measures during the capital account opening process was originally proposed with the intention of penalizing short-term cross-border speculative investment. And the tax rate could be 0.1 percent to 0.2 percent, for both capital inflows and outflows, he added.

The measures can curb "hot money" flowing into the domestic financial market in search of higher returns before rushing back out, as these activities will lead to fluctuations and crashes.

The capital account opening process has been on the nation's economic reform schedule for a long time. The topic was recently readdressed as top-level policymakers highlighted the "dual circulation" economic development model since May－a strategy to maintain economic growth momentum mainly by relying on the domestic market. It could be a core policy direction for the country's development plan for the next five years, according to analysts.

"It doesn't mean we will give up external markets. Instead, we will improve the quality of opening-up measures, especially for the financial sector," said Li Yang, director of the National Institute for Finance and Development, a think tank.

Li added that a more open capital market, especially the bond market, will help facilitate the internationalization of the yuan, another key reform to support the "dual circulation" economic development plan in the coming years.