By Michael Lelyveld
As President Xi Jinping lays out plans for China’s future development, it is unclear whether he will follow the accelerated reform course urged by People’s Bank of China (PBOC) Governor Zhou Xiaochuan.
In the days before this month’s 19th National Congress of the Communist Party of China (CPC), the veteran central bank chief raised expectations of major changes in monetary policy and capital controls with a call for faster reforms.
In a lengthy interview with Caijin Magazine on Oct. 9, Zhou made the case for further opening of China’s economy to international access and scrapping restrictions on capital flows.
“There isn’t a single country in the world that can achieve an open economy with strict foreign exchange controls,” said Zhou in remarks translated by Bloomberg News.
Zhou, 69, who is expected to retire in March after heading the PBOC since 2002, described a triad of “drivers” that should be taken together to make China’s economy “open to the outside world.”
On the list were the opening of trade and investment, a more market-based exchange rate mechanism, and reduced capital controls.
In a simplified version, Zhou called for “free trade, a free exchange rate and free capital flows,” the South China Morning Post said.
While that description strips away some of the more cautiously-worded nuances of Zhou’s recommendations, he argued for taking tough steps sooner rather than later.
“The time window is very important for reforms, an appropriate window must be seized. Once missed, the cost of reform will be higher in the future,” he said.
Western reactions to the interview suggested that the comments marked a significant development.
“The debate in China over economic reform has just become more interesting,” said The Wall Street Journal in an editorial comment. “Coming on the eve of the Communist Party Congress, this could be an important moment.”
Other observers saw Zhou’s remarks as less momentous.
“There’s nothing new in that statement. This is something that he’s articulated before,” said Harvard University economics professor Dale Jorgenson in a phone interview.
“The fact is that the bank has been pushing in this direction for some time,” said Jorgenson. Zhou was only fulfilling his role as spokesman for reforms and calling for “keeping clearer goals in mind,” he said.
In fact, a review of Zhou’s past statements finds similar calls for letting market forces “play a bigger role in determining the yuan’s value” and moving toward full convertibility as far back as 2004.
While China’s “opening up” has been gradual and halting, Zhou’s tenure has been marked by historic economic growth, along with doubts about commitment to easing state controls.
Major steps during Zhou’s terms in office have included the recapitalization of state banks starting in 2003 with reduction of nonperforming loans, the breaking of the yuan peg to the dollar with revaluation under international pressure in 2005, the credit-fueled stimulus in response to global recession in 2008, and the yuan’s inclusion in the International Monetary Fund’s basket of major currencies in 2016.
All were taken in the name of reform with mixed success and criticisms, while it remains unclear how much closer China is to full convertibility of the yuan with free capital flows and market-based exchange rates than it was a decade ago.
In his 68-page opening address to National Congress last week, Xi gave a nod to some of the issues raised by Zhou, but no indication of when the triad of reforms would take place.
“We will improve the framework of regulation underpinned by monetary policy and macro-prudential policy, and see that interest rates and exchange rates become more market-based,” Xi said.
Major changes in capital controls do not appear to be on the horizon.
Most recently, the government with the PBOC’s support has clamped down on outbound direct investment (ODI) in key categories to stem capital flight, hardly in keeping with Zhou’s stated goals for free capital flows.
In the first three quarters of 2017, China’s non-financial ODI plunged 41.9 percent from a year earlier, according to Ministry of Commerce data.
While Zhou’s recommendations may be seen as a policy framework, much of the PBOC’s management over the years has been aimed at putting out fires from market forces and credit policies that have threatened monetary controls.
The PBOC’s policy moves on exchange rates have also been abrupt and opaque. A sudden devaluation in August 2015, for example, left international markets in the dark and has yet to be fully explained.
Big battles have been waged against shadow banking and rapid debt growth with limited success.
The IMF has characterized China’s debt growth as “dangerous” at least three times since August 2016, yet the PBOC appears to be paying little more than lip service to reducing financial risks.
In his address to the congress, Xi called for efforts to “forestall systemic financial risks,” but offered few details.
Instead, Xi hailed the achievement of the country’s high growth rates, noting that gross domestic product had climbed from 54 trillion to 80 trillion yuan (U.S. $8.1 trillion to $12 trillion) in the past five years.
At meetings in Washington days before the party congress, Zhou suggested that China’s economy would again overtop targets with potential growth of 7 percent in the second half of the year as yuan-denominated lending continues to climb.
His assurances on the debt issue were highly qualified.
In a statement to the IMF’s International Monetary and Financial Committee, Zhou said that “potential risks in China’s financial industry have increased, but in general, the risks are manageable,” the official Xinhua news agency reported.
Despite the risk focus, new yuan-denominated loans in September jumped 13.2 percent from a year earlier as lending of 11.16 trillion yuan (U.S. $1.68 trillion) in the first three quarters rose 9.8 percent.
The above-forecast lending may be seen as a sign that the government’s balance of policy-making will continue to lean toward high growth.
During the congress, the National Bureau of Statistics announced that GDP rose 6.8 percent from a year earlier in the third quarter, while expansion in the first nine months maintained this year’s 6.9-percent pace.
An ‘appropriate window’
Although Zhou argued that China should take advantage of an “appropriate window” to reform its capital controls, it seems unlikely to find an opening as long as financial risks remain unresolved.
Some media reviews of Zhou’s interview have noted the cabinet-level status of the PBOC and its lack of independent authority as factors that expose recommended reforms to resistance.
But those hoping for a clearer picture of the conflicts behind China’s opaque policy-making are likely to be disappointed. In his interview, Zhou took care to speak only of “the inertia of some of the old thinking,” without naming the ministries or interests involved.
“I would say that rather than dissension within the ranks, this is just a statement that there should be an attempt to accelerate reforms that they have been discussing for some time,” Jorgenson said.
Zhou finessed the issue of the PBOC’s independence.
“I understand that this does not mean that the central bank is independent of the government, but that the monetary policy is independent and effective,” he said.
Zhou’s call for faster reforms and China’s uneven record of performance make it hard to predict what policies it will implement next. The statements may be little more than expressions of intent.
“Zhou almost always sounds like he’s pro-reform, in public. How hard he fights in private is unclear,” said Derek Scissors, an Asia economist and resident scholar at the American Enterprise Institute in Washington.
Scissors said China can’t lift its capital controls without a commitment to a long-term currency strategy.
“And we have seen over and over that Zhou doesn’t have the influence to force that decision,” he said.
“So, he’s either just posturing pre-retirement or trying to lobby the next (Politburo) Standing Committee. In my opinion, the lobbying is extremely unlikely to work and he knows that,” Scissors said.