JAPAN has expressed concern to China about the pace of capital outflows from the country and has suggested China moves very slowly in reforming its currency system to avoid repeating Japan’s past mistakes.

    After a summer of market turmoil, China now appears to be at a critical juncture as capital outflows reach hundreds of billions of dollars and the Chinese Government draws down heavily on its, albeit large, currency reserves to offset the impact of the money moving offshore.

    The stocks slump of more than 40 percent in a matter of a few months and the shock devaluation of the yuan acted as a reminder of how quickly China could lose control of its markets if it moves too quickly to open up to market forces, Japanese officials say.

    “The pace of capital outflows is alarming,” said a senior official with knowledge of Japan’s currency diplomacy. “If China’s financial system is destabilized, the effect on Japan and the rest of Asia would be enormous.”

    Publicly, Japanese officials have urged China to proceed with reform and expressed confidence that China has the tools and expertise to manage. But privately, they have adopted a different tone, cautioning China against moving too quickly to free up the yuan when large capital outflows could make the currency a target for speculators.

    Japan has conveyed its concerns to Chinese officials at various meetings this year, including at the G20 financial leaders’ meeting in Turkey in September.

    China took a big step toward internationalizing its currency Friday, when IMF staff and the institution’s head Christine Lagarde endorsed the inclusion of the yuan in the fund’s benchmark foreign exchange basket, known as Special Drawing Rights (SDRs). Analysts estimate inclusion could lead to demand for the yuan worth more than US$500 billion.

    “It should be the other way around,” said a Japanese official, who declined to be identified. “Reforms come first, then you debate whether the yuan can join the SDR.”

    China is trying to engineer a shift in the economy away from manufacturing and toward consumption and services while promising to fully liberalize the yuan by 2020, a goal some Japanese officials feel is ambitious.

    Japan’s cautious tone is at odds with the more robust calls from the United States, underlined last week with comments from U.S. Treasury Secretary Jack Lew urging China to press ahead with its reform plans.

    But Japan’s views carry weight with China, which has long taken a close interest in how Japan emerged in the past three decades as a global economic power.

    It views Japan’s handling of capital flows and the yen as key factors that led to its asset bubble blow-up in the early 1990s that led to nearly two decades of deflation Japan is still struggling to eradicate.

    For decades, China’s main concern was the amount of foreign currency coming into the economy as it built a huge export engine.

    But since China surprised world markets by devaluing its currency around 2 percent in August, net capital outflows have reached US$200 billion, a U.S. Treasury Department report showed last month.

    Japanese policymakers are not suggesting there is an immediate risk of a financial crisis, but they say China’s heavy intervention in markets to offset the capital outflows shows China is worried.

    If China liberalizes its currency too quickly and before it fixes other problems in the economy, such as high debt, China may struggle to contain capital outflows and that may take a toll on its US$3.5 trillion in currency reserves, Japanese officials say.

    “Market liberalization sounds nice. But it could cause various problems,” said Eisuke Sakakibara, who, as a senior Japanese finance ministry official, wrestled to contain volatile yen swings with heavy intervention in the late 1990s. (SD-Agencies)