MNI ANALYSIS: China PBOC Head To Retire Amid Reform Questions

By Nerys Avery

     LONDON (MNI) - For Zhou Xiaochuan, the man who has led the People's Bank of

China for a tumultuous 15 years, retirement appears to be imminent, although in

the black box that is Chinese politics nothing is ever certain until it's

announced. 

     The consensus is that having stayed on beyond the normal retirement age of

65 back in 2012 when Xi Jinping's new administration took the reins of power,

Zhou will, at almost 70, now have to exit. He is expected to lose his place on

the Central Committee, comprising the top 370 or so officials of the ruling

Communist Party, when it meets for its 19th Congress later this week, and will

be replaced as PBOC governor by January.

     Zhou rarely gives interviews, but earlier this month he turned to magazine

Caijing to give a lengthy overview of the country's financial reforms and his

opinions on the direction they should now take. 

     The governor reiterated the need to continue with the financial reforms he

has championed but that seem to have stalled under the leadership Xi Jinping - a

sign if ever there was one that his departure is on the near horizon.

     Zhou called for a troika of reforms - embrace free trade and investment,

dismantle controls over the capital account and continue to overhaul the

exchange-rate system to allow the market to decide the value of the yuan -

saying that an open economy was not possible without them. Whether his bosses in

the Politburo want an open economy is another question, however.

     He urged greater market access for foreign financial institutions, saying

trials had shown that the risks feared by policy makers had not turned out to be

as large as expected. He also issued a veiled warning to the leadership saying

that any window of opportunity to push ahead with reforms must be taken because

without such action the cost of reforms will rise in the future.

     Possibly reflecting his frustration at the pace of change and at the

opposition to reforms within parts of the policy-making circle, Zhou said China

cannot wait for conditions to be ripe to liberalize the exchange rate.

     GRIP ON POWER

     But Zhou's comments are those of an outgoing official who wants to put his

marker down. They should not be taken as a sign that the more conservative

leadership is going to turn the switch back to "on" for the reforms the PBOC

head began to implement and was then forced to halt. Expectations for any bold

moves on the part of Xi Jinping must be set in the context of reality - which is

the party's need for control, and the potentially destabilizing consequences for

a nation of 1.4 billion people of getting it wrong or miscalculating - without

mentioning the fear of the Chinese leadership of meeting the same fate as

Russia's Communist Party.

     Zhou become governor in 2002 at the start of an almost decade-long economic

boom and steered the financial system as the ruling Communist Party gave the

go-ahead to a series of fundamental overhauls to help the country integrate

itself into the global economic and financial system as part of its ambitions to

knock the U.S. and the dollar off their pre-eminent perches.

     These reforms, which are still in progress, include the shift to a

supposedly more market-oriented exchange-rate system that started in 2005, the

liberalization of the country's interest-rate system and the establishment of a

new regime based on money-market interest rates, opening up the capital account

and internationalization of the yuan which led to the historic but symbolic

entry of the yuan into the SDR, and, most recently, the development of inclusive

finance which is becoming a key plank of the government's economic policy.

     Yet Zhou's tenure has not been without missteps and backtracking, in spite

of his reputation. In June 2013, the PBOC badly misjudged liquidity conditions

which led to a destabilizing cash crunch in the interbank market that roiled

global markets. In August 2015, the central bank again shook global markets with

a badly communicated change in its exchange-rate management that led to a

de-facto devaluation of the yuan. December 2015 and January 2016 saw more forex

jitters after the PBOC launched a new trade-weighted index to value the yuan

against a basket of currencies and the yuan was allowed to drop precipitously.

     November and December 2016 saw the PBOC pull up the drawbridge on the

capital account to stem a deluge of capital outflows that was pressuring the

yuan and forcing the authorities to sell dollars by the bucket to stop the

Chinese currency from slumping. In May 2017, the PBOC introduced what it called

a "counter cyclical factor" into the way it calculates the yuan's daily

reference rate against the dollar, adding to market skepticism that it was

committed to a more market-driven system for valuing the currency.

     HIS MASTER'S VOICE

     Granted, Zhou may not have been making the decisions, but rather responding

to his master's voice. Nevertheless, these events don't burnish his image as a

reformer and champion of free markets. And even as he has touted monetary

prudence and the need to control financial risks and debt, Zhou has presided

over possibly the largest build-up of debt of any economy in modern world

history, the full consequences of which may not play out too long after he has

retired.

     The trouble started in 2008 when then Premier Wen Jiabao ordered banks to

open the lending taps to help support the economy and cushion it from the impact

of the global financial crisis. By the end of 2016, the country's total debt had

quadrupled to $27 trillion and non-financial sector debt stood at 236% of GDP

according to the IMF, up from 148% in 2007. The economy needs ever more debt to

meet the Communist Party's growth targets and in its latest Article IV report on

China released in August, the IMF estimated that total debt will double to $54

trillion in 2022 and that non-financial sector debt will rise to 296.7% of GDP.

     The fund has for several years been urging the Chinese leadership to rein

in debt and all three of the global ratings agencies have cut the country's

sovereign debt ratings in part because of the build-up of liabilities. Policy

makers are well aware of the warnings and the risks associated with such a rapid

accumulation of debt, and the cracks are already starting to appear in the

corporate sector where the debt problem is worst.

     Two years ago, President Xi Jinping started to call for action to begin the

process of deleveraging, and in May last year an unnamed senior party official

close to Xi told the People's Daily, the party mouthpiece, that high leverage

was an "original sin" and the root of all evil. Xi seemed to add to the sense of

urgency in April this year when he said that safeguarding financial security was

a "strategic and fundamental matter for China's social and economic

development."

     CRACKING DOWN...

     The focus so far has been on curbing leverage in the financial sector by

cracking down on financial institutions gaming a poorly-regulated shadow banking

industry. Some of the more risky practices are being reined in, such as the use

of leverage by financial institutions to buy high-yield wealth management

products, and the shifting of liabilities, especially high-risk loans, off

banks' balance sheets to be repackaged and sold as investments to other banks

and institutions. The PBOC is also cracking down on banks' use of the wholesale

markets to raise funds, with new limits on the issuance of negotiable

certificates of deposit and tighter control over how they are accounted for on

banks' balance sheets.

     There are some small signs of progress - data from the financial regulators

show that outstanding interbank assets and liabilities fell at the end of June

from the start of the year and have continued to shrink. Growth in wealth

management products (WMP) has also slowed, with the balance of interbank WMP

falling by CNY2.2 trillion from January to August 2017.

     In a report last month, economists at JPMorgan Chase & Co said that total

debt in the non-financial sector edged down from 269% of GDP in the first

quarter to 268% of GDP in the second quarter, while the corporate debt-to-GDP

ratio eased to 166% from 167%. Although they acknowledged the decline was

marginal, they said it was the first time since 2011 that total debt as a

percentage of GDP had declined.

     ...BUT DEBT STILL RISING

     These are small victories, to be sure. But other data show that debt is

still rising, with particularly strong growth in household debt.

     Figures released by the PBOC over the weekend show that the credit taps are

still flowing freely. Total social financing (TSF), the country's broadest

measure of credit that includes bank lending, equity and bond issuance as well

as shadow-banking activities such as trust loans and bankers' acceptances, was

CNY1.82 trillion in September, the biggest monthly figure since March, and new

loans were CNY1.27 trillion, the most since March. Outstanding TSF was up 13% at

CNY171.2 trillion at the end of September, still higher than the growth in

nominal GDP.

     At the IMF meetings in Washington last week, Zhou parroted the official

line that China's financial risks are "manageable", and the authorities have the

"capacity and confidence to prevent systemic risks and maintain healthy and

stable economic operations".

     Whether he believes that or not, it's not a problem Zhou will have to worry

about for much longer.

--MNI Beijing Bureau; +44 203-586-2244; email: nerys.avery@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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