China is about to have its first new central bank governor in 15 years. Zhou Xiaochuan on Friday presided over what was presumed to be his last press conference as head of the People’s Bank of China. His successor, expected to be named on March 19, will be charged with controlling credit growth, attracting foreign investors into China’s financial markets, limiting contagion from the shadow banking sector and creating a more sustainable exchange rate regime.
The next governor would do well to take lessons from Mr Zhou, who played a weak hand in China’s bureaucracy very skilfully, affecting policy beyond the bounds of his official station. Unlike most central banks, the PBoC is not independent. The State Council signs off on routine adjustments to interest rates, banks’ reserve requirements and exchange rate management. Its members generally want to keep credit abundant and interest rates low, and have no interest in empowering the PBoC.
Yet Mr Zhou managed to shape an aggressive financial reform agenda, including liberalisation of interest rates and the exchange rate. He used international expertise and engagement to frame choices for China’s leaders narrowly, portraying reforms as in line with those of other modern, developed financial systems. By introducing limited reforms that appeared innocuous, he ended up creating outsized effects that broke down state constraints on China’s financial system.
Consider two examples: the internationalisation of the renminbi and the light regulatory approach to China’s fintech companies. Letting the currency accumulate offshore set up expectations that onshore financial markets would also be liberalised and prompted gradual moves towards capital account convertibility. Allowing internet-based banking spurred the rapid growth of new players, forcing state banks to compete for customers and leading to the end of hard caps on bank deposit rates.
The leading candidates for the next governor include Guo Shuqing, head of the banking regulator, Jiang Chaoliang, party secretary of Hubei province, and Yi Gang, the current deputy governor. Mr Guo is the presumptive choice, but Mr Yi might run the bank’s day-to-day operations if a higher-level official such as Liu He takes the reins.
Last year’s imposition of capital controls puts the onus on the next governor to restore the credibility of China’s commitment to rules-based governance of the financial system. Capital outflows from China are inevitable as a $27.3tn money supply expands by about 10 per cent a year, creating powerful incentives for Chinese households and corporates to diversify into foreign assets. Capital controls will be of questionable long-term efficacy, and policy uncertainty continues to loom over exchange-rate management. Foreign investment into China’s financial markets would help offset the outbound capital, but attracting these inflows will require more reform.
Markets typically test new central bank governors, so early policy signals towards the interbank and foreign exchange markets will be important. Investors will be watching for changes to the PBoC’s historical aversion to credit defaults. The new governor must continue Beijing’s deleveraging campaign while preventing contagion from developing credit risks in China’s $39.7tn banking system. In June 2013, the PBoC backed down after an attempt to tame shadow banking resulted in an acute funding crunch. That arguably created conditions for the further explosion of shadow banking activity.
Under Mr Zhou, the PBoC has consistently been home to reform-minded officials, highlighting the continuing importance of individuals even in China’s centralised system. The next governor’s ability to preserve that legacy will help shape the future of China’s economy and its impact on the world.
The writer is director of China markets research at Rhodium Group