China's Toughest Job?
Zhou Xiaochuan, governor of the People's Bank of China, has guided his country's monetary policy for most of the 21st century. He was appointed in 2002, shortly after China joined the World Trade Organization, and helped steer its economy through the global financial crisis. In the process, he gained widespread respect at home and a reputation for prudent liberalism abroad.
Lately, Zhou has been circulating widely. At a forum in June, he criticized protectionism in China's financial sector. In an interview this month, he called for liberalizing the yuan. At a recent meeting in Washington, he warned about excessive corporate debt growth. Zhou, who will reach the typical retirement age of 70 next year, certainly sounds like a man on his way out the door. "People retire eventually," he told reporters yesterday, at an event at the 19th Communist Party Congress.
So what might be in store for his successor?
Whoever is picked as the next head of the PBOC, the policy path is fraught with risk. Despite China's much-hyped goal of making the yuan a global currency, it can't easily reform its foreign-exchange policy or ease capital controls without triggering a flood of outflows. A deceptive period of calm for the yuan this year was the result of a weakening U.S. dollar, which propped up foreign-exchange reserves. Any reversal for the dollar -- a likely outcome of the Federal Reserve's plan to tighten its balance sheet -- will bring the yuan under significant pressure once again.
The picture isn't much brighter on interest rates. To maintain the yuan's soft peg to the dollar, the PBOC's monetary policy generally follows the Fed's. But the two countries are now in very different places economically. China needs relatively low interest rates and abundant liquidity, while the U.S. risks overheating if the Fed doesn't boost rates and reduce its balance sheet. If the PBOC does follow the Fed -- with rates rising and liquidity falling -- it will place China's over-indebted economy under enormous pressure; if it doesn't follow the Fed, it risks breaking the yuan's peg to the dollar.
A more serious challenge is debt. The PBOC is attempting a very difficult balancing act, spearheading China's deleveraging efforts while also providing huge amounts of liquidity to the financial system. Through a combination of lending facilities, it has made net capital injections of 3.2 trillion yuan over the past year. Zhou's talk of restraining corporate debt was sensible, but at odds with current policy: New debt has risen by 16.4 percent so far this year.
At the heart of all these challenges are the conflicting goals of China's political leadership, which wants both reform and stability. China can't internationalize the yuan while simultaneously cracking down on outflows. It can't deleverage while ordering the central bank to increase lending by trillions of yuan.
And this suggests the biggest problem for the next governor. Unlike most central banks, the PBOC has no fundamental insulation from politics, and lacks a transparent, predictable, rules-based framework for setting monetary policy and priorities. Instead, the Communist Party dictates policy minutiae to the PBOC across a range of areas, from interest rates to foreign exchange.
So whether the next PBOC chief ends up being Deputy Governor Yi Gang, with a Ph.D. from Indiana University, or Jiang Chaoliang, the party secretary of Hubei Province, ultimately will have little bearing on monetary and foreign-exchange policy.
A better framework for understanding how the PBOC will act is to follow the direction of policy in the second term of President Xi Jinping. So far, there's little evidence that Xi is willing to yield control or accept the costs of addressing China's significant economic imbalances. Absent a change of heart, that means the prioritization of growth over reform will likely continue and risk will continue to grow.
The PBOC governor is the public face of China's economic policy. Ultimately, though, he answers to the Party. That makes at least one aspect of his job predictable: The next governor may or may not oversee the liberalization of the yuan or significant deleveraging. But he will undoubtedly try to remain in good standing with Beijing.
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