Author: Gregory Chin, York University
The idea of the People’s Bank of China (PBOC) being a weak central bank is a persistent misconception that afflicts our comprehension of China. Over the past three decades, the PBOC has gradually gained more control over day-to-day administration of the exchange rate and money supply. It remains involved in maintaining the financial stability of the country. It manages the largest portion of the world’s biggest foreign exchange reserve holdings, totalling more than US$3.5 trillion. It possesses a growing amount of operational autonomy, even if it does not have the only say over the goals of monetary policy.
The outlines of an increasingly capable, professional and influential People’s Bank are starting to emerge. We see a central bank that has pushed through interest rate liberalisation and incremental steps to ‘normalise’ monetary policy making, looking to further loosen capital and exchange rate controls. We see the PBOC emerging from a Leninist party-state that had guarded control over banking, macroeconomic policy and monetary policy. The fact that the RMB exchange rate has risen 23 per cent over the last three years suggests that the central bankers are winning some battles inside Chinese decision-making circles, and have achieved some success in convincing the powerbrokers that greater exchange rate flexibility and the loosening of capital controls are to China’s benefit. The recently issued guidelines from PBOC governor Zhou Xiaochuan, coming out of the Third Plenum, that China will ‘basically’ end normal yuan intervention further suggests that the central bank’s influence has grown more than appreciated to date. The missing link, in our collective understanding, is how we explain these changes in the governance of money in China. How was the PBOC transformed from a weak and fractured central bank into one that exercises growing influence, governing capability and, arguably, increasing operational autonomy?
The empirical evidence suggests a combination of factors has been critical over the past few decades. Starting in 1993, former governor of the central bank Zhu Rongji initiated a period of macroeconomic austerity and a new macroeconomic policy regime that delivered more controlled money supply and greater price stability. He held firm in refusing to lend additional money indiscriminately to the finance ministry to cover state budget deficits; strengthened the hand of central PBOC in the appointment and removal of branch heads in its provincial and large municipal offices; and oversaw the roll-back of 30 per cent of central PBOC lending to the financial system that was previously under the discretion of provincial and lower-level branch offices.
Zhu presided over the administrative reorganisation of the PBOC, which resulted in the closure of 148 duplicate PBOC branches across the country, and the consolidation of the PBOC’s 31 provincial branches into nine regional branches and two operations offices in Beijing and Chongqing. The issuing of the Law on the People’s Bank of China 1995 and the Rules on the Monetary Policy Committee in 1997, the creation of regulatory commissions for securities and insurance in 1998 and then banking in 2003 and the dissolution of the Party’s Central Financial Work Commission in 2003 strengthened the capabilities of the central bank and focused its attention more squarely on monetary policy, financial supervision (including oversight of financial services), forecasting, monitoring and controlling financial risks. Over the past decade, the PBOC has also rolled out a number of policies and initiatives to manage the world’s largest official reserves. We therefore see the rise of a more ambitious monetary elite, reformers in the PBOC and the State Administration of Foreign Exchange who are injecting rationality, flexibility and practicality into China’s approach to reserve management, as well as macroeconomic management more broadly.
Amid the 2008–09 global financial crisis, the central bank played the key role in designing coordinated interest rate adjustments that China undertook in concert with other leading central banks around the world, and it was crucial in the decision to introduce the massive domestic stimulus package in late 2008. The PBOC has thus gained increasing operational autonomy in controlling inflation, relaxing the exchange rate regime and capital controls, managing the ballooning foreign exchange reserves, and supervising China’s growing financial markets. Why have these significant changes in central banking in the PRC not received more attention? The lag effect of academic knowledge creation is only part of the answer. More important has been the ‘stickiness’ of conventional wisdom, and how the inertia of conventional thinking has weighed heavily on policy and scholarly debates.
Observers have continued to emphasise that the PBOC is ‘not an independent central bank as is commonly understood, but is instead guided by decisions of the State Council’. Others have argued that the Monetary Policy Committee that is affiliated with the central bank, and which was formed in 1997 to advise the central bank and provide the PBOC with some insulation from political pressure, has ‘failed to filter political signals out of monetary policy’. Others still have suggested that the PBOC ‘even now is playing a more advisory role’.
But the conventional wisdom of the PBOC being a weak central bank no longer seems to tell the whole story. Whereas the debate outside of China has fixated on exchange rates and absolute independence of the central bank or lack thereof, more systematic attention needs to be given to changes in the relative degree of autonomy of the PBOC; institutional and organisational redesign; the evolving governing capacity of the central bank; the actual and changing determinants of Chinese currency policy; and the evolving goals, needs and logic behind central banking in the PRC. Has the situation of central banking changed in China? If so, to what degree, how, when and why?
Inside the PBOC, and above it, the Chinese debate is about whether it would be a good scenario if the PBOC were fully independent, in ‘goals’ and ‘operations’ — especially as it is already growing in the latter; what would be the impact of such independence from the standpoint of the central bank serving the broader developmental needs of the country; and what are the lessons learned, coming out of the 2008–09 global financial crisis, on whether it is better or not to have a central bank that focuses more narrowly on managing the inflationary index, implementing price controls and setting interest rates.
Moving forward, it will be important to gauge how an increasingly influential PBOC is interacting with the other main financial regulators and market actors in the Chinese system in managing the ‘financialisation’ that China is now undergoing. The importance of the PBOC’s role in price stability and controlling money supply will only grow with increased cross-border use of the renminbi. Its role in ensuring financial stability across the national economy will be paramount as financial reforms are pursued. The PBOC has an indispensable role to play in curtailing shadow banking activities, non-performing loans, overinvestment and speculation in real estate, and in keeping commercial development under control. At the same time, pressure on the central bank will be unrelenting as financial liberalisation inside China becomes stronger in key locales, such as Shanghai, Tianjin, Guangdong, Zhejiang, Sichuan and Chongqing, over the next 3–5 years. For global financial stability, we should hope that the central bank succeeds in keeping atop of all these developments.
Gregory Chin is Associate Professor at York University, Canada. He is Co-Editor of the academic journal Review of International Political Economy.
This commentary is based on a longer academic article by the author, titled ‘Understanding Currency Policy and Central Banking in China’, Published in The Journal of Asian Studies, 72(3), August 2013, pp.519-538.