China to open capital account in 3 years: banker

China will have liberalized deposit rates within two years and have a fully convertible capital account a year later, the chief economist of Agricultural Bank of China, one of Beijing’s “big four” state banks, told Emerging Markets on Friday.

Xiang Songzuo pointed to Beijing’s determination to push through aggressive financial reform in its drive to create an economy fit for the 21st century.

“Everyone knows the financial reform is essential and welcome,” Xiang said, talking on the sidelines of the Institute of International Finance conference. “Even the premier, Li Keqiang, talks about it all the time. We need to encourage capital to flow into every corner of the financial sector.

“We need to cut our reliance on the formal banking system and create a full-service financial sector that includes healthy debt market capabilities, private equity funds, even funds designed [explicitly to support] small and medium-sized enterprises.”

Xiang’s predictions on the capital account and the freeing up of interest rates are unusually bold, even in light of Beijing’s clear desire to shake up the financial sector and inject competition. But he said China could only reform the industry by making hard decisions. “We need to be bold,” he said.

The process won’t be easy. China is often accused of promising much then delivering little. A classic example is the Shanghai free trade zone (FTZ), launched in early October.

Critics have been underwhelmed by the zone, but Xiang said it would grow in power and prestige. “The underlying objective is to promote Shanghai as a key financial centre, a key financial hub for the whole of Asia. We are going to test and pilot every sort of financial service there, including onshore-offshore capital flows” denominated in renminbi (RMB).

The creation of a fully global Chinese currency will take longer. Beijing is determined to turn the RMB into a leading currency, and in particular a leading trade-settlement currency.

But Xiang said that process is likely to take far longer, “probably as long as 20 years”. The process won’t be easy: liberalizing interest rates can in theory be done at the flick of a switch, but convincing multinationals and sovereigns to settle trades in an underdeveloped currency linked to a still largely isolated economy will be a harder sell.

However, China’s top leaders are keen to push ahead, spurred by the ongoing US federal shutdown, which has raised fears of a dollar debt default. Beijing holds 60% of its $3.5 trillion in foreign currency reserves in dollars.

China was “very fearful and worried” about a potential default of US Treasury bonds, an event that would hit the value of Chinese dollar holdings, he said.

Xiang added that the gridlock in Washington had “definitely accelerated” Beijing’s ambition both to diversify away from the greenback and to promote the RMB as a viable future alternative to the US currency.

“In some ways this is good news for China as the market is losing confidence in the US dollar,” he said. “The RMB is increasingly a potential alternative to the dollar, as Premier Li tells everyone when he travels around Asia and the world.”