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| Zhou: looking to reform rural financial system |
ZHOU XIAO CHUAN is in a relaxed mood. The governor of the People’s Bank of China is sitting in his Washington, DC, hotel suite during the IMF/World Bank meetings sipping a beer. Maybe Zhou is at ease because the gathering is closing and he is looking forward to returning to Beijing. Or maybe it’s because for the first time in a long while at an IMF meeting the biggest industrialized countries haven’t criticized China’s exchange rate policy, which Zhou oversees.
In a September 23 statement, the G7 said: “We welcome the recent decision by the Chinese authorities to pursue greater flexibility in their exchange rate regime. We expect the development of this more market-oriented system to improve the functioning and stability of the global economy and the international monetary system.”
For Zhou this is vindication of a policy that was first set in motion two years ago and that was finally executed when China was ready, not when the rest of the world dictated it should be. It is, he says, just one of a series of measures designed to strengthen the People’s Republic’s socialist market economic system.
New policy
Zhou says that to understand the revaluation of the renminbi properly, it’s necessary to go back to the third plenary session of the 16th Communist Party of China national congress in 2003. It was there that the Chinese authorities introduced a new policy document. “This document had been prepared for half a year, so the draft began just after the new government [led by president Hu Jintao] had been formed,” says Zhou. “In that document it was written that we would reform our exchange rate system.”
The intention was that China would establish a managed floating-rate system based on supply and demand. But as important was the way in which that goal was to be achieved. The liberalization of the exchange rate was just one link in a chain of financial reforms. “These had to be achieved before we reformed the exchange rate,” says Zhou.
The first was banking sector reform, including the wholly state-owned commercial banks, joint-stock commercial banks, city commercial banks and rural banking institutions.
The most important measures included financial restructuring of three of the four big state-owned banks: Bank of China, China Construction Bank, and Industrial and Commercial Bank of China. Massive doses of capital have been injected into these banks and most of their non-performing loans have been written off as part of the government’s attempt to modernize the banking system, according to the central bank. Zhou reckons that about 70% of China’s banking reforms are complete, although critics argue that the modernization process still has some way to go. Risk management practices, for example, are weak in most Chinese banks. A senior executive at Bank of China has admitted that he barely knows what’s going on in the bank’s branches in Beijing, let alone the rest of the country. The bank has 10,000 branches nationwide.
The next set of reforms was directed at China’s financial markets. One was to remove controls on foreign exchange transactions, including those on certain capital account transactions. Another was to deepen the development of the market to encourage domestic financial institutions, importers and exporters to operate in a more favourable environment and to adopt hedging tools.
Once the authorities felt that sufficient progress had been made on these issues, the stage was set for the revaluation of the renminbi on July 21 when the Chinese currency was allowed to appreciate by 2.1%. In addition, the renminbi’s peg to the US dollar was removed in favour of a basket of currencies, including the dollar, euro and yen. Initially, the renminbi had a trading band of 1.5% against the non-US dollar currencies. But in September the central bank widened it to plus or minus 3%. The move was taken to reflect China’s diversified trading and economic relationships with smaller countries, says the central banker.
Critics have pounced on the revaluation, characterizing it as little more than a cosmetic change. “There’s been no important change to China’s exchange rate system,” says one. “There’s been a very small appreciation of the renminbi, but it’s not significant. It’s still essentially a fixed-rate system.”
Zhou dismisses these attacks, arguing that the currency reform is significant. “It’s no longer a fixed exchange-rate regime. It’s a managed, floating exchange-rate system,” he says. “The principle is based on a market supply and demand relationship. The rate should gravitate to the equilibrium point.” What is also apparent is that China now has more flexibility in managing its currency system. By trading against a basket and by keeping the respective weightings to itself, China’s central bank can manage the renminbi far more anonymously than before.
Zhou rebuts the notion that pressure from the US government had any influence on the Chinese authorities’ decision. American politicians had been calling for a revaluation of the renminbi for two years. Some of the more bellicose members of the political establishment had even been calling for an unrealistic 25% revaluation. Zhou says that China’s strategy has always been clear.
“The US government and the IMF have understood since 2003 our sequencing programme and the conditions necessary [before reforming the exchange rate]. The G7 understood too. Maybe others didn’t understand, so they made some noise,” he says.