PBOC’s Rise to Top a Story of Deft Politics Amid Turmoil

Mar 7, 2013 11:22 AM EST

By Stephen Bell & Hui Feng

Youtube: https://www.youtube.com/watch?v=U9S6kdkY1yY

As of November 2012, the People’s Bank of China had total assets of $4.8 trillion, more than the European Central Bank or the Federal Reserve. The PBOC now supplies more than half the world’s total liquidity and manages foreign reserves worth almost $3.3 trillion.

Increasingly, the PBOC has become an international lender of last resort, particularly as European politicians try to persuade the Chinese to buy their bonds. No wonder that Zhou Xiaochuan, the bank’s governor, has been dubbed “the world’s central banker,” a man whose statements can move global markets.

It’s hard to believe that just three decades ago the PBOC was only a minor institution in the labyrinthine Chinese bureaucracy. Its ascension is a story of turbulent economic transition, skillful leadership and, above all, deft political strategy. And its most significant challenges may still lie ahead.

After the communist revolution, the PBOC was formally founded in 1949 as a national bank, authorized as the center of cash, clearing and credit to serve the Chinese economy.

In the 1950s, the PBOC became the only major bank in China, a universal system that performed rudimentary central-baking and retail functions. But it was marginalized by the financial repression and bureaucratic hierarchies of China’s command economy. From 1958 to 1962, the PBOC’s branches were merged with local government treasuries, and from 1968 to 1977 its head office of only 80 staff members operated as a minor department within the finance ministry. The bank was nothing but a bookkeeper, cashier and mint-master.

Deng’s Reforms

After Deng Xiaoping initiated a period of economic reforms starting in 1978, the PBOC gradually became China’s most important macroeconomic management agency. The emerging market and a rapid expansion of international exchanges demanded sophisticated financial intermediation that the PBOC’s universal system was unable to provide.

The PBOC gained independence from the finance ministry in 1979, and as a series of state banks were resurrected to engage in commercial business its role in the new system became a hotly debated question. After lengthy internal arguments, its status as China’s central bank was officially confirmed in 1983 and its commercial-banking businesses were given to the other state banks.

Inflation crises in the 1980s and early 1990s led reform-minded elites to push the PBOC to maintain price stability via the Central Bank Law of 1995. The law said that “The aim of monetary policies is to maintain the stability of the value of the currency and thereby promote economic growth.”

The central government also restructured the bank’s regional branches, giving them increased autonomy from provincial governments, which had traditionally been a source of investment-driven inflation. After central financial planning was phased out in 1998, the bank sought to modernize its monetary-policy apparatus and developed closer ties with the international community.

More important, PBOC leaders forged political ties with reformist party leaders, particularly Zhu Rongji, who had been the governor of the PBOC from 1993 to 1995 and went on to become premier in 1998. Zhu lacked broad support in the central government, but the PBOC provided policy and bureaucratic backing on a range of issues.

The PBOC thus won increased authority by becoming an indispensable ally for the reformist political leadership. Under Zhu’s leadership, the bank had engineered a soft landing in 1996 after a bout of high inflation (peaking at 24 percent in 1993), and won major arguments following the Asian financial crisis, especially in pursuing a strategy of non-devaluation.

Flexing Muscles

With its new authority, the PBOC began to flex its muscles in the 2000s, particularly under the governorship of Zhou Xiaochuan, an economist with intimate ties to the political leadership. Although the party still exerts control over the financial sector, the bank has been exploring new, more market-oriented instruments and mechanisms within its discretion to establish a credible monetary policy and maintain price stability.

From 1979 to 1994, economic growth averaged 10.1 percent while inflation averaged 7.7 percent. From 1995 to 2011, economic growth averaged 9.9 percent while core inflation fell to an average of only 3.1 percent. This track record gave the PBOC greater authority and room for maneuver in macroeconomic management.

The PBOC also played a central role in liberalizing China’s exchange rate in 2005 and again in 2010, despite mounting internal resistance. Recognizing the importance of a sound banking sector for carrying out monetary policy, the central bank also took the lead in recent banking reforms aimed at improving corporate governance and market discipline. Under Zhou, the bank has also been active in reforming the securities, insurance, and bond markets, internationalizing the renminbi, and establishing state-of-the-art payment and settlement systems.

But the PBOC still faces plenty of challenges. In the short--to-medium-term, it will have to address bad loan risks, especially an increasing prevalence of shadow banking and banks’ exposure to real estate and local-government debt. In the longer term, it will have to ensure stability as China transforms into a more domestically driven economy. What makes these tasks more daunting for the PBOC is that it must constantly bargain and negotiate with other bureaucracies and with the party leadership. It also must implement a more market-oriented monetary policy while constrained by the legacies of the communist past, such as state control of key financial sectors.

But the bank’s future depends on more than adroit political maneuvering. It must also stave off the kind of financial catastrophes that have besieged the U.S. and Europe in recent years. And that may turn out to be the most difficult challenge of all.

(Stephen Bell is a professor of political economy and Dr. Hui Feng is a research fellow in the School of Political Science and International Studies at the University of Queensland. Their latest book is “The Rise of the People’s Bank of China: The Politics of Institutional Change.” The opinions expressed are their own.)

Review

Book notes: The Rise of the People’s Bank of China: The Politics of Institutional Change

Author: Robert Pringle

Source: Central Banking Journal | 17 Feb 2014

Categories: Governance

Topics: People's Bank of China, China, Chinese renminbi (RMB)

Stephen Bell and Hui Feng, The Rise of the People’s Bank of China: The Politics of Institutional Change, Harvard, 2013, 376 pages

I first visited the People’s Bank of China (PBoC) in 1993, at a key stage in China’s reform process, which was overseen at the time by Zhu Rongji as economic czar (he was later prime minister). In my report, ‘The view from the People’s Bank of China’, Central Banking, Volume IV, No 3, 1993, I described the sweeping reforms being implemented by the central bank against a background of record-beating economic growth rates. The key test was whether the central bank could get a grip over its own provincial and lower-level units, which had autonomous credit-creation powers as a legacy of the old planning system. The risks of fragmentation of monetary control had destroyed the money of several societies that were in transition to a market system.

Until shortly before my visit, China’s central bank had been on the sidelines of economic policy-making, which was dominated by the state planning agency and the ministry of finance. It had pursued the two objectives of economic growth and currency stability; in future, it would only pursue one – currency stability. Previously, the central bank had allocated credit according to the principles of the planning system. There was strong political support for the reforms: China already had a 15-year track record of world-beating growth and a huge rise in real incomes, which had made reformers confident. But the central bank was still finding its feet. The main political opposition centred on demands for regional autonomy and vested interests, including privileged access to foreign exchange.
Growing authority
Stephen Bell and Hui Feng analyse the astonishing growth in the authority of the central bank since that time, nesting their story within a rigorous theoretical framework, meaning this book will appeal to both scholars and market participants. They provide a detailed account of the formal and informal institutional and political dynamics that formed the basis for the development of the central bank. They divide the crucial reform periods into the first great reforms of 1978-92 and the second reform era that started in the mid-1990s. Gradually, the plans on which I reported in 1993 became a reality, as the institution exploited the discretion afforded to it by acquiring greater authority and a secure place within the structure of governing institutions of one-party rule. The authors show how the institution has used its growing status to exercise a decisive say in the setting of policy, for both interest rates and exchange rates, and the ongoing reform of banking.

Their conclusions are finely balanced. On the one hand, it is wrong to portray the PBoC as a ‘puppet’ of the Communist Party. Equally, it does not enjoy a high level of independence; it has a limited, but increasingly well-defined role, and within that space has accumulated great authority.

Anybody studying China’s monetary history knows the horrors it has suffered from hyperinflation and currency depreciation in the past 100 years, notably following WWII. After that, inflation was repressed by the planning system. Banishing these inflationary devils has been a huge achievement, in which the dollar peg from 1994 to 2005 played a major role. The authors trace how the rising authority of the PBoC was shaped by fear of further inflationary crises. More recently, it has had to fight against consumer price index (CPI) inflation and asset-price bubbles. The time when I first visited Beijing, in 1992-93, marked a crucial transition to a more market-led monetary policy framework, but the authors believe the economy remains inflation-prone.

There have been several major economic cycles since then: the soft landing in 1996, the Asian crisis of 1997-99 and deflation followed by the emergency stimulus of 2009. This was mandated by party leadership and, the authors argue, represented a “setback” for disciplined monetary policy and for the PBoC.

The PBoC under Zhou Xiaochuan, governor for the past 10 years, has been the major force behind the move to reform the exchange-rate regime despite political resistance, say Bell and Feng. China has developed a managed currency basket-based system, and overseen a successful appreciation of the renminbi. At the same time, the PBoC has developed a distinctive approach to reserve management, as well as developing a payments infrastructure that has played a critical role underpinning rapid economic growth.
A work in progress
Owing to such a record, the PBoC has grown into a “policy heavyweight” and an “indispensable ally” of the political leadership: “these political and institutional dynamics of mutual dependency, set within facilitative change contexts, have been the key to explaining the puzzle of the rise of the PBoC’s authority” (p299). The authors say the central bank enjoys considerable discretionary space in a number of policy areas, including bank reform and foreign exchange sterilisation policies. Banks have been restructured as shareholding companies. The central bank has fought both CPI inflation and asset-price booms.

The PBoC does not seek the approval of its Western counterparts, nor has it copied others. The consensus in China has long been that the country needs to find its own way at its own pace. The PBoC is the world’s largest central bank by assets and “the major supplier of global liquidity”. Its M2 money supply is said to be 52% of the world total, and Zhou has been called “the world’s central banker” by Standard Chartered Bank – a description dismissed as false flattery in China.

The rise of the PBoC remains a work in progress. The institution is still politically vulnerable to any perception of policy weakness or failure. It faces major challenges. As in the West, the search for a strong monetary anchor continues. In the authors’ view, greater exchange-rate flexibility and full interest-rate liberalisation will become essential. Beyond that, ultimately, “the political deficiencies of authoritarian rule will have to be addressed”.
Robert Pringle