Learning from China’s economic philosophy and policy — XVII

Here, it needs to be mentioned that connecting the Shanghai and Hong Kong stock exchanges, and also Shenzhen and Hong Kong stock exchanges, in a two-way direction provided greater ease of investment than in other programmes due to no-limit investment opportunity with regard to this ‘Connect’ policy, as indicated in ‘The handbook of China’s financial system’: ‘In late 2014, China unveiled the Shanghai-Hong Kong Stock Connect.

The bidirectional scheme allowed domestic investors, both institutional and individual, to participate in Hong Kong’s equity market, and global investors to take advantage of mainland’s A shares. …Unlike the QFII [Qualified Foreign Institutional Investors], QDII [Qualified Domestic Institutional Investors], and RFQII [Renminbi Qualified Institutional Investors] programs, investors participating in the Stock Connect are not subject to individual quota limits, hence finding it more convenient.

Also read: Learning from China’s economic philosophy and policy — XVI

A similar Shenzhen-Hong Kong Stock Connect was introduced in late 2016. In addition, the Mutual Recognition of Funds program, introduced in mid-2015, allowed funds based in Hong Kong to be distributed to mainland investors, and vice versa…’

Also read: Learning from China’s economic philosophy and policy — XV

It needs to be indicated that while China has meaningfully loosened capital controls, but in the overall spirit of ‘gradualism’, and not ‘shock-therapy,’ whereby regulation continues to remain significantly strong overall, as pointed out in the same handbook: ‘Only major policy shifts can change [International Monetary Fund’s] AREAER’s [Annual Report on Exchange Arrangements and Exchange Restrictions] values.

Also read: Learning from China’s economic philosophy and policy — XIV

But China has opened up its capital account gradually. For most types of capital transactions, restrictions are relaxed rather than removed. This explains why most Chinese officials hold a glass-half-full view of China’s de jure openness.

Also read: Learning from China’s economic philosophy and policy — XIII

The Quinn index, by contrast, is designed to capture the enforcement of capital controls.’

Moreover, China (rightly) loosened capital controls on foreign direct investment (FDI), and in a relatively delayed, and more cautious way with regard to much more volatile foreign portfolio investment (FPI).

Also read: Learning from China’s economic philosophy and policy — XII

The same handbook indicated in this regard ‘…China’s capital account liberalization has been mostly successful. In four decades, China has attracted $3.1 trillion of foreign direct investment; its external assets and liabilities have grown from virtually nil to $7 trillion and $5.5 trillion, respectively. It has withstood the shockwaves of Asian and global financial crises. …China liberalized direct investments before opening its door to portfolio and other investment flows. Both literature and experience have favoured FDI as the best type of capital inflows. Not does it help form new plants and create new jobs, but it also brings in technology and managerial know-how.

Also read: Learning from China’s economic philosophy and policy — XI

Moreover, FDI is long-term and stable, posing lower financial risks than other types of capital flows. The right sequencing of opening up has enabled China to reap the benefits of FDI while keeping at bay the dangers of fickle capital flows…’

On the other hand, Pakistan has failed to develop strong economic institutions and improve the underlying workings of its organizations and markets. Doing so would require employing non-neoliberal policies—such as dual-track pricing—under a mind-set that favours a proactive public sector.

All of these measures significantly contribute to sustainable macroeconomic stability, economic growth, and the attraction of foreign direct investment (FDI).

Also read: Learning from China’s economic philosophy and policy — X

Instead, Pakistan has mistakenly pursued a policy of competing for highly volatile foreign portfolio investment (FPI) by maintaining policy rates higher than necessary to keep inflation stable and predictable. Furthermore, these high rates add greater volatility to the capital account by encouraging rent-seeking carry trades.

Also read: Learning from China’s economic philosophy and policy — IX

A more moderate policy rate would keep the cost of capital supportive of domestic investment and FDI, allow greater scope for counter-cyclical government policies, and foster a better balance between aggregate demand and supply-side measures.

Here, it needs to be pointed out that at lower stages of economic development, China even adopted a cautious approach while opening up to FDI, providing, in turn, important underlying lesson that appropriate level of caution needs to be taken even with regard to FDI, to protect against ‘inefficient investment booms.’ Taking such caution is important till an appropriate level of economic institutional quality is reached that can better understand more and less efficient FDI for the economy.

Also read: Learning from China’s economic philosophy and policy — VIII

The same handbook pointed out in this regard: ‘Opening-up is not once and for all, even for FDIs. In the early 1980s, Chinese market economy was in its infancy, and the government had limited experience in managing it. A premature opening-up to capital inflows, even to growth-enhancing FDIs, could have led to inefficient investment booms. Instead, China conducted pilot programs first, establishing 4 Special Economic Zones in 1979, then another 14 Economic and Technology Development Zones in 1984.

Also read: Learning from China’s economic philosophy and policy — VII

Foreign capital received more preferential treatment and operational autonomy in these special zones. It was only after the success of these pilot that China decided to fully embrace FDI. Since 1986, China has allowed foreign capital to receive tax benefits, regardless of location. While it is difficult to analyze counterfactual scenarios, the volatile growth and inflation that occurred in the 1980s suggested that an unchecked “FDI boom” would likely exacerbate China’s economic overheating.’

Also read: Learning from China’s economic philosophy and policy — VI

While China was cautious with regard to opening up to FDI, it was rightly all the more careful in its approach while loosening capital controls with regard to FPI, given the highly volatile nature of FPI, providing important lessons for Pakistan, which has struggled to manage carry trade, and FPI to bring greater stability to capital account, and overall macroeconomy.

Also read: Learning from China’s economic philosophy and policy — V

The same handbook pointed out in this regard: ‘So, China opened up to portfolio investments even more cautiously. Relying on schemes, regulators decide which investors and how much portfolio capital to flow in and out.

Also read: Learning from China’s economic philosophy and policy —IV

Participation in QFII was initially restricted to long-term investors such as central banks and sovereign wealth funds. Only after QFII’s initial popularity and success did regulators broaden it to include more institutional investors, and to relax various restrictions such as maximum individual quotas, minimum holding periods, and reparation rules.

Also read: Learning from China’s economic philosophy and policy — III

However, short-term speculators still faced tight restrictions for accessing China’s financial assets. QDII and RQFII have been following similar steps to expand. After successfully launching these “Q schemes,” China unveiled the Stock and Bond Connects. These “C schemes” are more flexible in that both institutional and retail investors have access to them, subject to no individual quotas. On top of the open-market “Q schemes,” the launch of QDLP and QDIE expanded the investable asset classes to riskier private equities and debts. Both QDLP [Qualified Domestic Limited Partner] and QDIE [Qualified Domestic Investment Enterprise] started with small quotas to control risk. …China has picked the right sequence of opening up, and has proceeded gradually.

Also read: Learning from China’s economic philosophy and policy — II

By adding small but incremental opening-up steps, China has substantially improved capital account convertibility without straining its developing financial system.’

Also read: Learning from China’s economic philosophy and policy – I

It needs to be mentioned here that the inclusion of China’s RMB into International Monetary Fund’s (IMF’s) currency basket that determines the value of IMF’s currency called special drawing rights (SDR) will bring greater predictability to the movement of SDR, given relatively stronger capital controls apparently placed by China under the overall non-shock therapy economic philosophical mind-set than in the case of other currencies included in the SDR basket, which are US dollar, Euro, Pound Sterling, and Japanese Yen.

(To be continued…)

Copyright Business Recorder, 2026