On 11 December 2001, the People's Republic of China (henceforth known as China) officially became a member of the WTO. A feature of China's WTO membership requirement is that it significantly liberalises trade in financial services. This liberalisation could be expected to have large impacts on China and the rest of the world. The scale of impact will largely be determined by China's current degree of financial integration, and a measure of assessing the degree of financial integration is the ability of capital to move freely between countries. However in China, a detailed capital control regime exists which could prevent the movement of capital, thus reducing the degree of financial integration. If capital movement were restricted by capital controls, then financial integration would be low. However, the existence of capital controls does not mean that they are necessarily effective. For instance, Gunter (2004; 1996) presents data that show large amounts of capital flight from China, indicative of the ineffectiveness of China's capital controls.
The more ineffective capital controls are, the more it can be considered that China is financially integrated with the rest of the world. It follows that if China is already currently financially integrated (or not integrated), then the impact of future external financial liberalisation mandated by its WTO ascension agreement is likely to be small (or large). A corollary here is that if China was already financially integrated during the 1997 Asian financial crisis, then we can conclude that China's capital controls were not the answer to China's strong performance during the crisis as many have claimed. If this were the case, then China cannot be held up as an example of the benefits of capital controls.
This thesis attempts to examine the effectiveness of China's capital controls drawing on the theoretical framework of financial parity in credit and capital markets. A vector autoregression (VAR) model is employed to examine the degree of financial interdependence between China and the countries under study in this thesis. The empirical result appears to indicate that China is not financially integrated within Asia. This suggests that capital controls still restrict financial flows between China and the rest of the world. Drawing on this result, the impact of financial liberalisation within and outside China is discussed. Finally, policy implications of the sequencing of reform in China will be addressed.