In the past, China has employed Qualified Foreign Institutional Investors (QFII) and Qualified Domestic Institutional Investors (QDII) programs to allow some degree of freedom in cross-border capital flows. In 2008 and 2009, China established bilateral currency agreements with some of its major trading partners, including Singapore, Russia and South Korea. The main purpose of these agreements was to mitigate foreign exchange risks against an ever-more volatile U.S. dollar.
More recently, measures were announced that allow holders of renminbi outside China to circumvent capital controls and invest Chinese currency back in China. In August, offshore banks and foreign central banks were allowed to invest in the renminbi interbank bond market. Also, renminbi fund transfers among individual accounts became possible in Hong Kong -- which directly facilitated the issuance of renminbi-denominated corporate bonds by foreign companies. As of this writing, Mickey D's renminbi bonds are selling like hotcakes in Hong Kong. These developments have certainly added to the expectation that the Chinese currency may eventually become a regional, if not a worldwide, reserve currency.
Further capital control reforms, however, will work well only in conjunction with reforms in exchange-rate regimes. As a previous IMF study pointed out, if China's current exchange-rate regime remains unchanged, capital account liberalization may pose significant risks to its still-immature financial system. As capital inflows become larger, the pressure on the renminbi to appreciate will intensify.
Rather than revaluing the renminbi, the Chinese government's policy priority should be allowing greater flexibility in the renminbi exchange rate. In the context of the financial crisis, it might have been the wise move to peg the renminbi temporarily to the dollar. However, as the world heads from recession to recovery, it is certainly in China's own best interest to establish a meaningful foreign exchange market and to increase independence in its monetary policy.