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Should China open its capital account in a hurry?

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Among the comprehensive list of China's economic reform pledges issued recently after the landmark Third Plenum, financial reform is high on the agenda.

As a matter of fact, Beijing has already stepped up its commitment to financial reforms in the past few months with a slew of liberalization measures including further expanding the QFII quota, scraping the floor on lending rates for China's commercial banks and establishing a free trade zone in Shanghai, among others.

Foreign exchange rate, interest rate and capital account reforms are among the three most important areas in China's overall financial reform; and they will have a series of profound, far-reaching influences both within and outside China.

The key is finding the right pace and balance, and sequencing these reforms in the right fashion.

With respect to the pace and sequence of China's rates and capital account reforms, I checked with Paola Subacchi, Director of International Economics Research at Chatham House. She believes that China should take a prudent approach toward liberalizing the capital account.

"I think the gradualism is correct," Subacchi told me referring to the tempo of China's financial liberalization. "I strongly believe that the capital account liberalization should be restrained, because there is risk of too much capital movement in China."

"But I think in my view, it would be very important and good for China to reform the interest rates," Subacchi added.

"I know it's happening, to reform the interest rates and make the exchange rates more flexible so that the exchange rates can be adjusted by the market, and the interest rates can be determined by the market. And that should really encourage China to make some adjustment, without, however, opening the capital account."

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