From a longer term perspective, greater financial integration with the rest of the world is probably inevitable, with China now becoming the fourth largest economy and the third largest trading nation. Indeed, large financial crises in the past such as the Mexican crisis of 1994 and Asian crisis in 1997-8 have not prevented global financial integration. An open capital account has been generally considered as an ultimate policy objective in the Mainland, as its many benefits are well recognised. However, there have been lots of debates mostly with regard to the pace of the reforms. Although the stable macroeconomic conditions, the improvement of the financial institutions' balance sheets, and the enhanced supervisory framework in recent years have increased the economy's resilience, there are vulnerabilities. Most notably, financial market development and the price discovery mechanisms are still at their early stage, and the risk management capacity of the financial institutions and the corporate sector remains limited. It is therefore understandable that Mainland policymakers would prefer a gradual, controllable process in capital account liberalisation, in order to reduce the shock on the domestic financial system from capital flows. Hong Kong fits well into this prudent strategy. It is well positioned to help the Mainland to manage the process of liberalisation, while ensuring important reforms move forward steadily. This unique role derives from Hong Kong's proximity with the Mainland and shared culture and language, the close cooperation of the financial authorities of the two sides, and importantly, Hong Kong's status as a well-established international financial centre.

Indeed, this crisis has brought us to a juncture where a better understanding of capital account liberalisation – through learning from in-depth analysis and open debates – is required in order to formulate better policies in the area. The potentially destabilising effects that capital flows could inflict on the domestic economy are widely recognised. When it rains, it pours: as noted by an NBER research, capital flows tend to be pro-cyclical. 1 Large influxes of capital could push up the value of currencies, drive up inflation and fuel asset bubbles, while affecting the competitiveness of the export sector, posing challenges to the authorities of the host country in managing domestic monetary conditions and maintaining financial stability. Capital flows can also quickly reverse, often driven by changes in market sentiment or external environment. The “sudden stops” of capital flows have, in recent decades, brought severe financial stress to emerging markets, with substantial costs to the real economy. Such volatility is perhaps one main reason why the cross-country studies on growth benefits of a more open capital account have remained largely inconclusive. The current financial crisis brings home the message that integration with the global financial market could expose a country to global financial turbulence even when its own financial sector and real economy are fundamentally sound. Despite the recent turbulence and the spillover effects of capital flows, we should not, in my view, lose sight of the many benefits of an open capital account.