Renminbi convertibility remains among the largest obstacles to Shanghai’s financial emergence, but the green light will not be given until the central government is ready.
Convertibility would be an important step forward for Shanghai’s financial enterprises. While venture capital (VC) and private equity (PE) firms have incorporated outside of Shanghai, raised funds overseas, and listed portfolio companies in foreign exchanges, many would prefer to be able to tap into domestic markets without convertibility concerns.
"People aren’t used to having their capital confined," said Bill McGrath, a partner at MWE China Law Offices. "The conversion itself is not the problem; the problem is disinvesting or withdrawing your investment."
Continued reluctance to make the renminbi convertible puts Shanghai in a weak position compared with regional rivals. "For as long as China continues to have foreign exchange controls, Hong Kong will be a very useful place for the outflow of capital, " said Maurice Hoo, a partner at law firm Paul Hastings.
To be sure, convertibility is on the central government’s agenda, motivated by factors beyond advancing Shanghai as a financial center. Without the ability to invest beyond China’s borders and with only a limited number of asset classes available at home, asset price bubbles are unavoidable.
"In recent months, you see signs that the government is more worried about inflation and asset bubbles," said Zhang Chun, finance professor at China Europe International Business School. "You can’t deal with this without reforming the renminbi exchange rate."
Setting the stage for convertibility will take more than just government decree. Shanghai has already played an important role in a national pilot program using the renminbi in cross-border trade settlements, but the development of the city’s financial sector is crucial to the success of any further reform. Deep financial markets offering a wealth of financial investments, including derivatives and bonds, would make it easier to internationalize the renminbi.
In particular, a bond market with a sufficient choice of interest rates and maturities to produce a yield curve is a key component of nuanced monetary policy. Given China’s bond market is dominated by a limited range of state-issued bonds, full convertibility is still a long way off, and Deng Xiaoping’s decree – "Shanghai was the financial center in the past, where currency was freely convertible. We should make it the same in the future" – remains unfulfilled.