China’s Outgoing Central Bank Governor Leaves an Impressive but Fragile Legacy

Zhou Xiaochuan at the 19th National Congress of the Communist Party of China in October 2017. Photo: Getty Images.
Zhou Xiaochuan at the 19th National Congress of the Communist Party of China in October 2017. Photo: Getty Images.

During his 15 years in office, Zhou Xiaochuan has freed up China’s financial markets, established the renminbi as a global currency, expanded capital flows and presided over generally strong growth and low inflation. But as he prepares to retire as governor of the People’s Bank of China (PBoC), Zhou, 70, knows his legacy is not yet secure.

Unlike in the West, the powers of China’s central bank governor are limited. The PBoC comes relatively low down in the bureaucratic pecking order. The bank is not independent. It executes monetary policy, but the big decisions on the level of interest rates and the value of the currency are made at the highest echelons of the ruling Communist Party.

These constraints make Zhou’s achievements even more remarkable. Take the renminbi. Until 1994, foreign visitors were forbidden to possess the Chinese currency and had to use foreign exchange certificates, a form of Monopoly money worthless outside China. Yet by 2015, under Zhou’s nurturing, the renminbi had won the International Monetary Fund’s stamp of approval as one of the five main global currencies.

Zhou set the ball rolling in 2005 when he persuaded the leadership in Beijing to scrap the renminbi’s longstanding fixed peg to the dollar so it could float, to some degree, in response to economic conditions. As a reform-minded economist, Zhou knew that allowing market forces to play a greater role in determining the exchange rate and interest rates was critical to improve the allocation of capital inside China and thus raise economic efficiency.

In the same vein, Zhou has overseen the modernization of China’s money and capital markets. Once derided as casinos, the markets are still carefully monitored by the state. But their transformation is such that Chinese bonds and equities are likely to be added soon to global indexes, making them much more attractive to foreign investors.

Zhou has long championed easier inflows and outflows of capital – alongside a freer-floating exchange rate – as a means of galvanizing China’s lumbering state-owned banks to raise their game and adapt to market signals instead of blindly carrying out state orders.

Speaking of his reform agenda, he told an interviewer last year: ‘There’s an English saying: We’ve passed the point of no return.’ But recent history shows that’s not necessarily true.

Xi Jinping appears to have no great interest in economics. But he is determined to strengthen his own power and that of the Communist Party. To that end, economic and financial policy decisions must serve above all to cement political and social stability. So when China’s stock market crashed in 2015 and the country was haemorrhaging foreign exchange reserves, the politburo clamped down on capital outflows and took a tighter grip once more on the renminbi. Efforts to promote the international use of the currency were put on hold.

The episode was an undoubted blow to Zhou and fellow reformers. Xi is set to rule for as long as he chooses once China’s parliament rubberstamps the party’s proposal to scrap the 10-year limit on the president’s term of office. So further economic liberalization as urged by the central bank chief will continue to depend on which way the political winds are blowing. Right now, the state is strengthening its control of the economy, not loosening it.

A second reason why a question mark will remain next to Zhou’s legacy is that he must share the blame for not having offered greater resistance to the credit boom ordered by the leadership to bolster growth after the financial crisis of 2008. Even if the economy is now back on a firm footing, critics say debt has risen so sharply that a wave of defaults and bankruptcies is inevitable at some point, with serious repercussions for the global economy.

Perhaps with an eye on his place in the history books, Zhou recently warned that China might indeed be enjoying the calm before the debt storm. Don’t blame me if things go wrong from here, he seemed to be saying.

A fluent English speaker comfortable with foreign journalists, Zhou could have been contemplating the reputational fate of his peer, former US Federal Reserve chairman Alan Greenspan. Once hailed as the ‘maestro’, Greenspan is now faulted for sowing the seeds of the financial crisis by keeping interest rates too low for too long.

So it is too early to pass definitive judgment on Zhou. For now, though, he can point to an impressive track record at the PBoC that has contributed significantly to China’s meteoric rise this century.

Alan Wheatley, Associate Fellow, Global Economy and Finance.

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