China's chief central banker speaks out

Zhou Xiaochuan, China's chief central banker, has some fascinating insights into the future challenges for the world's second-largest economy.

Central bankers have assumed an air of omnipotence during and after the global financial crisis because of their awesome power to create and destroy money.

Their decisions and influence extend beyond financial markets. Their power to withdraw funds has not only the potential sink banks, but elected national governments.

Neil Irwin, the author of The Alchemists: Inside the Secret World of Central Bankers, dubs the trio of Ben Bernanke, Mario Draghi and Mervyn King the committee of three that saved the world from another great depression.

In his seminal book, Irwin devoted one of his final chapters to a less well-known central bank chief: Zhou Xiaochuan, the governor of the People’s Bank of China. The Chinese central bank has become a lot more technocratic and reformist under his guardianship.

Though the Chinese central bank is not independent like other major central banks like the Fed and European Central Bank, what Zhou says and thinks matters for the world’s second largest economy.

Zhou recently took part in a panel discussion at the World Economic Forum at Davos, where he outlined his take on global financial volatility and, more importantly, the Chinese economy.  

  1. On the housing market

The housing market is arguably the Achilles heel of the Chinese economy. So what does Zhou think of the state of real estate sector, which is a major contributor to GDP growth?

The short answer: he is not too concerned.

Zhou maintains the economy is still in reasonable shape despite some cyclical turbulence. His diagnosis of the housing market problem is that it is reasonably benign.

He says China is very big with many cities, and the performances of the housing markets across these cities are quite different. “There are problems of oversupply in some places, and in some cities the demand is still very strong,” he said.

Essentially he does not think the housing downturn is a very serious problem across the entire country. The central bank’s view is that the housing market is just going through a period of cyclical adjustment. Some reports lend support to the view, but there seems to a problem of oversupply in a lot of third tier and fourth tier cities where demand is not as strong as in major cities.

The central message is China’s housing market is too varied to make sweeping generalisations. It is also interesting to note that when he asked about what tools would the central bank use to boost the housing market if the situation got worse.

His answer is that it is difficult for the central bank to form a policy that is specifically designed to counter a downturn in the housing market when all other economic indices such as GDP growth are relatively robust.

He says the central bank monitors the housing market through macroprudential policies such as watching over loan-to-value ratios and the bank’s special lending facility to build low-cost housing. “There is not much we can actually do,” he said.

  1. On global commodity prices

As the world’s largest importer of many commodities from oil to iron ore, China is an important price-setter. So what does the central bank chief think about the recent slump in commodities prices, especially the falling oil price?

Zhou thinks the falling oil price is a plus for the economy, and it makes his job easier to fulfil mandates to maintain employment and economic growth. However, the central banker is concerned that the declining oil and gas prices could send the wrong price signal to people who want to invest in renewable energy projects.

He says the Chinese economy is trying to readjust its energy consumption structure by reducing its reliance on fossil fuel consumption. Zhou is worried that the price signal could distort people’s incentives to invest in renewable energy and it could have the potential to slow down investment in renewable energy.

  1. On central bank forward guidance

Central bankers have the magical power (up to a point) to get what they want without actually doing what they promise to do. For example, Mario Draghi, the president of European Central Bank, managed to pull off an amazing bluff in 2012 when the eurozone was teetering on the edge of an imminent collapse.

 “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough,” he said.  His words calmed down the market even though there was a big question mark about whether the ECB could actually deliver on that “whatever it takes” promise.

More recently, central bankers have pulled off a string of surprises that raise questions about how they communicate to market about important policy changes. The Chinese central bank is quite notorious for its Friday evening surprises on important decisions such as rate changes.

When he was asked about how central banks should communicate their decisions to the market, he offered the following observations. Zhou says it is important for central banks to offer verbal guidance to the market when the official interest rate is in the range of the zero lower bound. The Fed, the ECB and the Bank of Japan fall into this category.

However, he says, when normal monetary policy levers such as cutting interest rates are still effective, it is not necessary to offer verbal guidance to the market. 

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