Not Your Average Zhou: China's Central Bank Governor Finally Speaks

Zhou Xiaochuan, the urbane governor of China’s central bank for the past 13 years, gave a lengthy interview on Saturday to media outlet Caixin. This represents Zhou’s first public comments on China’s economy in almost five months, the last time being when he attended a meeting of G-20 finance ministers and central bankers in Ankara, Turkey, in September. In the intervening time China’s stock market and currency, the renminbi (RMB), have continued to display substantial volatility despite (or perhaps because of) extensive government intervention. Market confidence in China has declined precipitously, with some questioning the basic capacity of Chinese authorities to govern their economy. The purpose of Zhou’s interview was to reassure Chinese and global markets.

Q1: What did Zhou say?

A1: On the one hand, a lot! This interview ran to almost 13,000 characters, or 16 pages in Chinese, and 13 pages in the translated English version). On the other hand, not much. His comments went only slightly beyond what other Chinese leaders and the official media have said. But he made some important clarifications. Several substantive comments stand out.

Most important were his remarks about the RMB. He reaffirmed the official policy of maintaining a relatively stable exchange rate and not permitting a large devaluation. Breaking somewhat new ground, he said that currently the RMB is not precisely pegged to either the U.S. dollar or a basket of currencies. Since December authorities have more clearly referenced the 13-currency basket when setting the initial daily rate and intervening, but they have not rigorously tried to maintain a peg. He said the goal was to move to a more rigorous peg but gave no timeline.

He defended the current exchange rate and argued against devaluation by noting that China has had higher growth and lower inflation than the United States and other major economies, as well as a large trade surplus, all of which suggests a stable or even appreciating currency over the long term. He turned away the argument that a devaluation is justified to stem capital flight. He no less than 20 times used the terms “speculate” and “speculators” to criticize those who are irresponsibly betting against the RMB, and by implication, shorting China, and said China would fight against these efforts. He also blamed the U.S. Federal Reserve for exiting quantitative easing and its December 0.25 percent rate hike for generating greater capital outflow pressures on China.

Second, he explained why he believes China still has strong growth prospects. He stressed: (1) China’s high savings rate, which translates into a high investment rate; (2) Likely continued growth in exports, particularly as China moves to higher value-added manufacturing; (3) Room for growth in services, which has surpassed 50 percent of GDP last year; and (4) Further steps to open up investment opportunities for private capital (he specifically did not say “foreign capital”). Noteworthy is that the first two elements are indicative of China’s traditional growth strategy; the governor did not directly emphasize the potential contributions to growth through improvements in efficiency or total factor productivity.

Third, he dismissed the notion that China’s slowdown was causing a fall in global commodity prices. The volume of imports of commodities, such as oil, rose in 2015, but since prices have dropped so much, the total value of imported commodities has shrunk.

Fourth, he suggested that the rise in capital outflows from China was not “hot money” looking to escape but rather the result of a rise in outward investment and efforts by domestic borrowers of foreign funds to repay those debts early in expectation of a weakening RMB. He sees the early repayment steps as healthy “autonomous” actions of Chinese businesses and a one-time adjustment, after which the pace of outflows should slow.

Finally, Governor Zhou talked at length in the last section of the interview about the central bank’s strong interest in developing a digital currency for the country. He gave no timetable but said that previous efforts to modify its paper currency had each taken about 10 years. Given China’s size and the complexity of the transition, “a digital currency will coexist with cash for quite a long time before it finally replaces cash.”

Q2: Did Governor Zhou provide a specific defense of the current exchange rate level?

A2: As noted above, he primarily made the argument in relative terms. He made what appears to be a circular argument about how to determine when a currency is in equilibrium:

Our aim is to have the exchange rate ‘broadly stable at an adaptive and equilibrium level,’ and there are interactions between the two. Although the equilibrium level defies an accurate assessment, a broadly stable exchange rate level can only be achieved when it is around the equilibrium level. Stability is impossible when the exchange rate is at a wrong level or in disequilibrium. Meanwhile, the pursuit of an equilibrium level can only be facilitated by the presence of general stability. Few will heed fundamentals or equilibrium analysis in times of turbulence and turmoil.

Q3: Will his comments reassure the business community?

A3: Given his strong reputation, some inherently trust Governor Zhou and may reassess their concerns or at least the sense of alarm that seems to have taken hold in some quarters. But many are so spooked by China’s policy volatility, rising debt, and slowing growth that these comments will not make much of a difference. Many in the business community are looking for unambiguous signals that China is committed to liberal economic reforms, not only in the future, but in the near term. Using that criteria, Zhou did not deliver. He counseled patience with the current approach and specifically said that economic reforms would not follow a “straight line” in order to avoid “transition traps” and “reform fatigue.”

Q4: Did he explain the central bank’s approach to communication, or why he hasn’t spoken publicly in so long?

A4: The governor suggested that he has refrained from speaking sooner because speaking to markets in and of itself would not solve China’s economic problems or reduce the inherent uncertainty in global markets. “The central bank is not God nor [a] magician that could just wipe the uncertainties out,” he said. In a sense, he seemed to be rejecting the notion that part of his job description is to explain China’s economic situation and reassure markets. This defense is not entirely unreasonable, but it does not explain why he has been quiet for so long. There are rumors that Governor Zhou disagreed with the massive intervention in the stock market last summer and has kept quiet to show his dissatisfaction and let others take the blame. Conversely, given the problems with the renminbi in the wake of reforms that he strongly pushed for in order to prepare the RMB to join the International Monetary Fund’s (IMF) Special Drawing Rights (SDR) basket, his standing internally may have suffered as well. In this second interpretation, the leadership may have determined that it was necessary for Zhou to finally speak because of his international standing.

Q5: Why did he speak to markets through an interview with Caixin?

A5: Caixin has a strong reputation as an advocate of liberal economic reforms due to the leadership of its founder Hu Shuli, who reportedly has close ties to economic technocrats, including Zhou. Speaking through China’s official state media would have been viewed less favorably by international markets, and giving an interview to a foreign media organization, such as the Wall Street Journal or Bloomberg, would have been looked down upon by China’s political establishment.

Q6: Is this the start of an effort to speak to markets more regularly?

A6: Governor Zhou will likely speak four times in the coming two months: this Friday at the China 50 Forum, at the G-20 meeting later this month in Shanghai, during China’s annual legislative session in the first half of March, and at the Spring meetings of the IMF and World Bank in Washington, D.C., in mid-April. The legislative session is most important for the domestic audience, as he will hold a press conference and face questions from domestic and international media, but the others deserve close monitoring as well. At the Spring meetings last year, Zhou explained that China would pursue “managed convertibility” of the RMB, the notion that China would gradually open its capital account but permanently reserve the right to intervene in certain circumstances “to maintain the stable value of the currency and a safe financial environment.”

But beyond these specific events, markets should not expect a more regular schedule of statements from Governor Zhou. He is unlikely to start speaking as often as his counterparts in the United States, the European Union, and other advanced industrialized economies. In between his comments, observers will need to pay attention to the statements of the central bank’s vice governors, reports on their website, and comments from China’s other officials, including Finance Minister Lou Jiwei; Liu He, head of the party’s Leading Small Group on Economics and Finance; and Premier Li Keqiang. However, far more important than all of them is President Xi Jinping, the only person in the country who can speak absolutely authoritatively about the country’s economic direction and policies.

Scott Kennedy is deputy director of the Freeman Chair in China Studies and director of the Project on Chinese Business and Political Economy at the Center for Strategic and International Studies (CSIS) in Washington, D.C.

Critical Questions is produced by the Center for Strategic and International Studies (CSIS), a private, tax-exempt institution focusing on international public policy issues. Its research is nonpartisan and nonproprietary. CSIS does not take specific policy positions. Accordingly, all views, positions, and conclusions expressed in this publication should be understood to be solely those of the author(s).

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Scott Kennedy
Senior Adviser and Trustee Chair in Chinese Business and Economics