Opening up China’s economy could offset the global trade slowdown - new ODI paper

22 January 2016

The global integration of China's economy and internationalisation of its currency is likely to produce further financial market volatility in the short term, but could ultimately offset the global trade and investment slowdown, a new report by the Overseas Development Institute has said.

The paper, "China's Balancing Act", describes how the country's contribution to world trade and investment following the internationalisation of the Chinese currency, the renminbi, could protect developing and emerging economies from the "triple crises" of higher US interest rates, lower oil and commodity prices and China’s own growth transition.

It warns however that China's liberalisation brings risks as foreign capital flows introduce new competition for less profitable banks and non-financial corporations.

Report author Phyllis Papadavid, team leader on International Macroeconomics at the ODI, said: “The markets are understandably nervous at the moment. Historical experience of liberalisations shows they, more often than not, generate currency crises. There will be much attention on the economic situation in China at the World Economic Forum in Davos this week.

“However, it is important to understand that China is the second largest economy in the world and has the policy infrastructure in place to manage its slowdown and reform in a sustainable fashion.

“The internationalisation of the renminbi is expected to lead to more inward and outward capital flows which can offer opportunities for developing countries and for China, if managed well. At the same time, its continued transition to consumption-led growth will ultimately support global demand."

The paper notes how moving beyond the "impossible trinity" of a fixed exchange rate, independent monetary policy and opening an economy, needs to be managed carefully amid volatility in global capital flows.

It predicts China's policymakers will reform at a slow and steady pace, and recommends the creation of a shock facility in light of the current global financial risks to mitigate these risks.

Notes to editors

·         Currency internationalisation denotes widespread currency usage in international transactions with the removal of restrictions on cross-border transfers of funds, on third-party use in contracts of trade in assets or goods and on assets denominated in the currency in private or official portfolios (Genberg, H. (2010) Currency internationalisation: Analytical and policy issues. Working Paper 61. Basel: BIS)

·         In 2005 the World Bank published an analysis of the historical experiences of liberalisations - “Financial Liberalisation: What Went Right, What Went Wrong?” in, Economic Growth in the 1990s; Learning from a Decade of Reform http://www1.worldbank.org/prem/lessons1990s/chaps/07-Ch07_kl.pdf

·         Further information on the “impossible trinity” can be found in The Trilemma in History: Tradeoffs Among Exchange Rates, Monetary policies, and Capital Mobility, a 2004 working paper  by Obstfeld, M., Shambaugh, J.C. and Taylor, A.M. http://www.nber.org/papers/w10396.pdf

·         The World Economic Forum Annual Meeting will take place in Davos, Switzerland, from January 20 to January 23, 2016

For more information or interviews with the report’s author contact ODI’s Senior Media Office James Rush on 07808 791265 or email [email protected]