TOKYO • Japan has expressed concern to Beijing about the pace of capital outflows from China and has suggested that Beijing moves very slowly in reforming its currency system to avoid repeating Japan's 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 Beijing 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 per cent in a matter of a few months and the shock devaluation of the yuan acted as a reminder of how quickly Beijing 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 destabilised, 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 Beijing has the tools and expertise to manage.
But privately, they have adopted a different tone, cautioning Beijing 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 G-20 financial leaders' meeting in Turkey in September.
China took a big step towards internationalising its currency last Friday, when IMF staff and the institution's head, Ms Christine Lagarde, endorsed the inclusion of the yuan in the fund's benchmark foreign exchange basket, known as Special Drawing Rights (SDR).
Analysts estimate that the inclusion could lead to demand for the yuan worth more than US$500 billion (S$712 billion).
"It should be the other way around," said a Japanese official, who declined to be identified because of the sensitivity of the matter. "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 towards consumption and services, while promising to fully liberalise the yuan by 2020 - a goal some Japanese officials feel is too ambitious.
Japan's cautious tone is at odds with the more robust calls from Washington - underlined last week with comments from US Treasury Secretary Jack Lew urging Beijing to press ahead with its reform plans.
But Japan's views carry weight with Beijing, 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, which then led to nearly two decades of deflation that 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 per cent in August, net capital outflows have reached US$200 billion, while Beijing appeared to have spent US$229 billion in foreign exchange intervention to prop up the yuan in the third quarter, a US 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 Beijing is worried.