April 2006

The evidence of “hot money” clearly shows that China’s cumbersome system of capital controls is not as effective as officials claim. There is no doubt that the greater openness of China’s economy will certainly generate growing tensions with the country’s closed capital account. China must put in place a sound institutional framework and financial infrastructure to accommodate increasing freedom of cross-border capital flows. Provided China can make meaningful progress in banking reform in the next three to five years, full currency convertibility remains a highly worthwhile and realistic medium-term policy goal.