Future Chinese Involvement in World Finance

With the world’s second largest economy after the United States, China has definite potential to exert strong influence on the global economy. However, largely due to the government’s reluctance to laissez faire, it hasn’t yet fully capitalized on its clout, especially in the global financial sector. But all that may soon change, as China’s central bank chief said in early April that China may loosen overseas investment regulations for private investors.

Historically, China first voluntarily opened up to foreign trade and investment under Deng Xiaoping in 1978 with his new capitalist-inclined system that promoted market forces. Since then, China’s financial sector has undergone significant reforms but it still exhibits the legacy of a centrally- planned economy in which the government, to this day, plays an instrumental role in credit allocations and pricing of capital. In addition, the government instituted a myriad of regulations that control both foreign investment into China and Chinese investment in foreign investments. Hindered by a maze of administrative procedures, foreign investors in China have complained that the Chinese government does not allow them to compete fairly with native businesses. Chinese investors that want to invest overseas, too, are heavily limited by esoteric guidelines.

However, beginning in October of 2011, the Chinese government took a significant step toward freeing up its hold of the financial sector. The deregulations include allowing foreign companies with RBM deposits outside of China to use their offshore account to directly invest in China, and allowing direct investment overseas for private Chinese investors in Wenzhou, also known as a “general financial reform zone” experiment. The government, afraid of the volatile international financial sector, decided to allow Wenzhou–a city in China recognized as the “birthplace of China’s private economy” due to its role as leader in developing a commodity economy, household industries, and specialized markets in the early days of economic reforms–to experiment with direct investment overseas. Concerns over inflation and property risks have held back the Chinese government from allowing a larger-scale deregulation, but nonetheless the Wenzhou experiment is widely acknowledged by the international community as a significant step forward.

Besides de jure governmental regulations, there are many de facto barriers to Chinese involvement in foreign trade. The most prohibiting factor to foreign trade is not what the laws say, but rather the existence of confusing, and often conflicting, laws at all levels of government. A unitary state with 23 provinces, 5 special autonomous regions, 4 self-governing municipalities, 2 special administrative regions, and a hierarchy of departments at all levels, China has innumerable bodies with legislative and enforcement powers that can influence foreign firms’ operations. Many foreign, and even native, companies have vocalized the impossibility of navigating the Chinese bureaucracy. A common phrase in Chinese business circles is, “It’s okay since no firm is 100% in compliance with regulations.” This trend poses significant legal risk for potential foreign investors.

Another substantial barrier to investment in Chinese markets is the inability of foreign private equity firms to freely convert RBM into other currencies. In terms of entry into Chinese market, foreign entrants must obtain special permission from the Ministry of Commerce to make investment in China using foreign currency-denominated funding pools. The Ministry of Commerce, then, picks certain transactions that it considers beneficial for the country and its policies. Later, the lack of RMB convertibility means that it’s difficult for a company to get its profits out of China. Again, companies require Ministry of Commerce permission, and are subject to different regulations depending on which individual in the Ministry handled the case, and his or her interpretation of the laws. Currently, successful foreign companies in China exploit the murky financial environment by taking advantage of unpredictable legal enforcement and shady accounting through local knowledge and networks.

However gloomy and risky foreign investors view the opportunities in China, one thing is for certain: they all want a slice of the large economic pie. “The more open China is to the world, the more benefits China will get and the more competitive local industry will be,” said Li Xiaogang, director of the Foreign Investment Research Center at the Shanghai Academy of Social Sciences. Following a similar philosophy, the Chinese government has begun responding to international pressure and removing itself as the referee in the financial markets. Ironically, Chinese deregulation may eventually level out the playing field in China’s financial sector, and with foreign companies as players, all the participants may reap benefits.