People's Bank of China Gains a Little Independence
(Bloomberg View) -- China looks set to get a new central bank governor this month. Incumbent Zhou Xiaochuan has seen it all during his 15 years in office: China’s surge to become the second-largest economy, the global financial crisis, ending the yuan’s fixed peg to the dollar and winning the currency inclusion in the International Monetary Fund’s reserve basket.
For all those changes, the People’s Bank of China is still subservient to the ruling Communist Party and its goals. The National People's Congress, a legislature that usually rubber-stamps the party’s desires, will vote on a new central bank chief on March 19, according to a parliamentary agenda.
Yet that lack of formal independence, something the central banks of most major economies enjoy, belies a key development little understood outside the salons of central banking. The PBOC has found ways to increasingly act on its own initiative, according to Alex Wolf, senior emerging markets economist at Aberdeen Standard Investments in Hong Kong.
Whoever succeeds Zhou faces an array of challenges, not least of which is finding a balance between promoting economic growth and stabilizing debt. But the incumbent has left the newbie with a suite of new tools to manage those challenges and a PBOC that’s quite different from the one that greeted Zhou on his arrival in 2002.
I sat down with Wolf, a former foreign-service officer who worked at the U.S. embassy in Beijing, last month in Hong Kong and spent some time in a follow-up email interview. Here is a lightly edited transcript.
Daniel Moss: It’s often taken as a given that China’s central bank isn’t independent in the way of the Federal Reserve, the European Central Bank or the Bank of Japan. Is this picture too simplistic?
Alex Wolf: It’s correct to say that the PBOC isn’t independent in the way the Fed, ECB or BOJ are. But the PBOC’s tools and monetary policy framework have evolved a lot in recent years in ways that have given it slightly more independence than in the past to control liquidity and guide interest rates.
The PBOC has, perhaps, one of the broadest, most difficult mandates of any major central bank in the world. It is simultaneously responsible for maintaining growth, price stability, currency stability and the health of the financial sector. Historically, all this had to be done without any control over interest rate decisions as all benchmark rates moves would need political approval.
China’s capital flows have shifted from large current and capital account surpluses to more modest surpluses, as a percentage of gross domestic product. The PBOC has used the opportunity to gain greater control over liquidity and to guide interest rates.
As a result more traditional benchmark rates -- bank reserve requirements, deposit rates and lending rates -- haven’t been used much in the last few years. Instead the PBOC has created other tools such as the SLF (standing lending facility) and MLF (medium-term lending facility) to manage financial system liquidity. Not only are these lending operations more effective, but importantly the central bank doesn’t require political approval to make changes to the rates of these lending tools, so their greater use has given the PBOC more independence to control liquidity and interest rates.
DM: Are you saying that the bank’s “lack of independence,” in the Western sense of the term, obscures more than enlightens?
AW: Yes. While not entirely independent to set monetary policy, and the bank is responsible for carrying out a very complicated mandate, Zhou’s team has built a more sophisticated set of tools and improved ability to pursue their mandates.
Greater freedom to set policy rates and control liquidity, as well as the use of more regulatory powers, has given the PBOC an increased ability to carry out its mission. While political priorities will take precedence, the PBOC has quietly used the change in capital flows and monetary conditions to gain more control over the financial system.
DM: What PBOC actions require approval by the political leadership and what can be done without sign-off from above?
AW: It’s not entirely clear (as with most things in China), but I garner that rates considered “benchmark” rates -- the reserve requirement rate, the lending rate, and deposit rates -- require approval. All other market operations and the newer lending facility rates don’t need assent.
It might not be worth speculating on the reasons why, but the benchmark rates are seen having a much stronger signaling power, and perhaps the newer tools are less well understood by politicians. The big question is how this might change going forward. Growth has rebounded quite strongly in recent quarters so there hasn’t been controversy over monetary policy decisions. But when growth eventually slows, if the PBOC is seen as maintaining policy that is too tight, perhaps there could be more political control over market rates.
DM: PBOC Governor Zhou is widely expected to retire soon. What will be his legacy?
AW: He was a very powerful influence for financial sector reform and was a driving force for the modernization of China’s financial system. Over his term he dealt with financial crises and rapid changes in China’s economy, and shifting domestic politics all while steering the central bank with remarkable stability and pushing significant reforms.
DM: Do we have sense of who will succeed him?
AW: As usual, the selection process has been opaque, but the current front runners appear to be Liu He, Xi Jinping’s closest economic policy adviser and current head of the Financial Stability and Development Committee; and Guo Shuqing, the current head of China’s banking regulator (CBRC).
Guo has a wide range of experience across politics, banking, and regulatory agencies. In addition, Guo has shown skill as an administrator and leader of large organizations, so he would be a natural fit for the role. That said, Liu has a closer relationship with President Xi Jinping, so if he wanted the job, it could be his.
Recent reports have talked about merging the banking and insurance regulator into one regulatory body, so perhaps there could be a role for Guo to stay at the helm of the larger regulator if Liu He gets the PBOC job. After all, Guo has been very successful as a banking regulator, both as governor of Shandong province and now as the head of the CBRC, so perhaps that is a better fit and better use of his talents.
DM: What will be the biggest challenge for the new head of the PBOC?
AW: The economy is in a stronger position than it has been in years, but the challenges will be many. How to progress with reform, especially the capital account, while the Federal Reserve is raising rates will be a challenge.
There are still persistent outflow pressures and with rising U.S. rates and a potentially stronger dollar, the PBOC will have to balance currency stability (through likely higher rates) with needing to support growth.
Also, balancing the growth-debt tradeoff will be a consistent challenge. Growth targets are still around 6.3 percent over the next two years, which will likely require ample credit growth. But with already high levels of debt, the PBOC will have to balance supporting growth with efforts to maintain financial system stability. That’s never an easy task.
Additionally, with rising global interest rates, a stronger Chinese currency, and a complicated and rapidly evolving financial environment, the impact of poorly managed monetary policy would be quite high.
Also, Zhou’s domestic and international credibility allowed him to push reforms through the system and allowed the PBOC to carve out some independence over policy settings. Given the increasingly centralized nature of policymaking, it’s not hard to imagine a scenario where the PBOC governor is hamstrung by a need to discuss every decision with party officials.
Of course it depends who eventually gets the nod, but at least at the moment, it appears Xi is entrusting financial policy to trusted technocrats. Growth is healthy at the moment, so it is not a controversial decision. The big question is how this might change when growth slows.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Daniel Moss writes and edits articles on economics for Bloomberg View. Previously he was executive editor of Bloomberg News for global economics, and has led teams in Asia, Europe and North America.
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