Zhou Xiaochuan: Central Bank Governor Who Modernized China’s Financial System

Zhou Xiaochuan, the face of China's financial system for 15 years, is expected to officially step down as governor of the People's Bank of China (PBOC) on Monday, having led the institution through momentous changes that transformed it from a bit-player to one of the most important central banks in the world.

His retirement is set to be announced days after the government released plans for a sweeping overhaul that will see the central bank gain considerable new regulatory powers over the financial system and its institutions in order to prevent and control financial risks.

Few central bank chiefs anywhere in the world in modern times can legitimately claim to have guided their country through as many milestones and reforms as Zhou, who had the ability to combine his jovial persona with a gravitas that earned the respect of politicians, government officials, financiers, economists and investors both at home and around the globe.

Exchange-rate reform that moved global markets, monetary policy management through the global financial crisis, interest-rate system overhaul, capital account liberalization and the yuan's elevation to reserve currency status — Zhou's guiding hand was on them all, even though the central bank’s lack of independence meant that the fundamental decisions were made by the State Council or the ruling Communist Party's top leadership.

Zhou is the longest-serving governor of all central bank chiefs in member countries of the Group of 20, a forum that brings together government and central bank leaders from 20 of the top industrialized and emerging economies.

'Exceptional mind'

He is “one of the most respected governors around the table,” Benoit Coeure, a board member of the European Central Bank, told Caixin in December. “When he takes the floor, everyone stops to listen to him, which is not always the case in international meetings.”

Jean-Claude Trichet, former president of the European Central Bank, told Caixin, “Zhou has an exceptional mind. We had some fantastic cooperation. His way of presenting things, his lucidity and kindness, were exceptional.”

A fluent English speaker, the PBOC chief has been lauded by the international financial community — and not just for his reform efforts and technical knowledge. “What people don’t necessarily know about Governor Zhou is that is he is an avid player of badminton and tennis. Both sports demand stamina, agility, speed, precision and strategic skills, all of which come [in] very handy for a central banker,” Christine Lagarde, managing director of the International Monetary Fund (IMF), said when introducing him at an IMF lecture series in June 2016.

Domestically, Zhou has gained a reputation as a staunch reformer who helped push through fundamental changes that transformed China from a centrally planned to a market-based economy which is now eight times bigger than it was when he took the helm at the PBOC in December 2002.

“If the market can solve the problem, then let the market do it. Regulatory agencies can only act as referees, not athletes or coaches,” Zhou famously said in 2000 when he was appointed head of China’s securities regulator.

He also made a name for himself as a scholar, publishing numerous academic papers and authoring books including “March Toward an Open Economic System” and “Addressing Risks During Transformation.”

“Zhou Xiaochuan has made an outstanding contribution to China's economic reform and financial stability in the face of unusually complex circumstances,” said Yu Yongding, a senior economic adviser to the government and a former member of the PBOC's monetary policy committee. “Although we've had occasional differences of opinion, I hold him in very high esteem.”

Like many of China's top officials, Zhou started out as an engineer. He graduated from the Beijing Chemical Engineering Institute in 1975 and obtained a doctorate in automation and system engineering from Tsinghua University. His father, Zhou Jiannan, served as head of the Ministry of Machine-Building Industry in the 1980s.

Zhou was greatly influenced by his father and was introduced to Western economics in the early 1980s, said Wu Jinglian, one of China's most revered and influential economists and a researcher at the Development Research Center at the State Council. “He learned his economics entirely from English-language books,” Wu said.

In 1986, Zhou was assigned to the institutional reform research group of the State Council, often referred to as China's cabinet, to work on economic restructuring. He served as assistant minister of foreign trade and economic cooperation from 1986 to 1989 and was concurrently commissioner of the State Commission for Restructuring the Economic System, according to a brief biography on the PBOC's website.

Zhou cut his teeth in the financial industry with a stint at the Bank of China and became head of the State Administration of Foreign Exchange (SAFE) before moving to the PBOC as a deputy governor and concurrently head of SAFE from 1996 to 1998. He then spent two years as president of China Construction Bank before serving as chairman of the China Securities Regulatory Commission from 2000 to 2002 where he gained a reputation for fighting corruption and protecting retail investors. He returned to the central bank as governor in December 2002.

Exchange-rate reform

Zhou took the reins at the PBOC at the start of an almost decade-long economic boom in China as the ruling Communist Party approved a series of fundamental overhauls to help the country integrate itself into the global economic and financial system. These reforms, which are still in progress, included the shift to a 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 entry of the yuan into the Special Drawing Rights, and most recently the development of inclusive finance, a key plank of the government’s current economic policy.

In 2002 the yuan could not be used outside of China. Its value was held at around 8.3 per dollar for 10 years before the central bank embarked on a long march to overhaul the system. The first step was taken in July 2005 when the PBOC announced it was de-pegging the yuan from the dollar and shifting to a managed floating exchange-rate system with reference to a basket of currencies. At first, the yuan was allowed to trade within a daily band of 0.3% on either side of a daily reference rate set by the PBOC, a range that was gradually widened to 2% in March 2014.

Zhou was instrumental in pushing for the internationalization of the yuan, also known as the renminbi, and implementing measures to allow it to be more freely converted into other currencies both on the current account, to pay for goods and services in international trade, and on the capital account, which involves the purchase and sale of assets and liabilities such as stocks and bonds.

In January 2018, the yuan was the world's fifth most-active currency for international and domestic payments and the eighth most used in terms of international payments, accounting for 1.66% and 1.07% respectively of all such settlements, according to data from the Society for Worldwide Interbank Financial Telecommunication. In comparison, the U.S. dollar accounted for 42.7% of international payments while the euro accounted for 36.5%.

The opening up of the capital account has been a much slower process, especially since the global financial crisis, as the Chinese authorities saw the potential risks to economic stability and the financial system of allowing capital to flow freely into and out of the country. Nevertheless, China persisted with efforts to gain a bigger status for its currency on the global stage and on Nov. 30, 2015 its hard work paid off when the executive board of the IMF approved the inclusion of the yuan in the basket of currencies used to value the Special Drawing Rights, the Washington-based lender's official reserve asset, effective October 2016.

Although the yuan has now joined the U.S. dollar, the euro, the yen and the British pound as an official reserve currency, it still has a long way to go in terms of becoming a truly global reserve asset. The yuan accounted for 1.1% of global allocated foreign-exchange reserves held by official monetary authorities at the end of September 2017 compared with 63.5% for the dollar, 20% for the euro, and 4.5% each for the yen and pound, the latest IMF data show.

Financial liberalization

On the domestic front, Zhou has overseen a broad swathe of reforms, including cleaning up and listing the big state-owned banks and opening the banking sector to competition, helping to set up and expand the interbank bond market which is now the third-biggest bond market in the world, overhauling the interest-rate system to make it more market-based and giving foreigners greater access to China's financial markets.

Zhou has been a staunch supporter of opening markets to competition. “Experience in China and in other countries shows that protectionism only leads to laziness, softer fiscal constraints and rent-seeking, which will weaken our competitive power and harm the development of this sector,” he said during a June 2017 forum in Shanghai, referring specifically to the banking sector.

But greater competition and freer markets led to a boom in shadow banking — financial activity outside the formal banking system that took place with little oversight or regulation — and made the financial system more complex as institutions developed innovative products and services, and exploited loopholes and gaps in supervision.

“During Zhou's tenure, the entrepreneurial part of the Chinese economy was given a huge boost through easier access to credit,” said Andy Rothman, an investment strategist focused on China at Matthews Asia, an investment management firm. “Companies were also allowed to experiment and push the envelope, with regulations coming after risks appeared.”

The regulatory system struggled to keep pace with the changes. The existence of separate watchdogs for securities, insurance and banking meant there was no unified regulatory framework and the lack of coordination among them allowed companies to engage in risky and irregular practices.

The government started to address these shortcomings last year. In July the Financial Stability and Development Committee was set up as a cabinet-level body to strengthen supervision of the financial system, prevent systemic risks, formulate new laws and regulations, and coordinate the various regulators that oversee China’s sprawling financial industry.

And in the most significant shake-up in the structure of China’s financial regulatory framework since 2003, the government announced on March 13 that the China Banking Regulatory Commission and the China Insurance Regulatory Commission would merge as part of the overhaul of the state bureaucracy.

Although Zhou was a firm proponent of overhauling the financial system, he also recognized that reforms should only be carried out when conditions were right, and emphasized the need to grasp “windows of opportunity.” In an interview with Caixin in 2016, Zhou said, “one should take decisive action when windows of opportunities open up, but refrain from reckless moves in the absence of such windows.”

In the months before he stepped down, Zhou became increasingly vocal about the need to tackle the systemic risks that were building up in the financial system, including excessive debt and a boom in asset prices. He emphasized the urgency of reform and opening-up, arguing that doing so would ensure financial stability and improve the performance of financial institutions.

Minksy moment

At a press conference during a key five-yearly meeting of the Communist Party in October last year, the 19th Party Congress, Zhou warned that the country must take measures to avoid a “Minsky moment,” a situation where asset values suddenly collapse as a result of an unsustainable buildup of debt and credit-fuelled speculation, and trigger a financial crisis.

“If there is too much optimism during a period of prosperity, tensions will build up which could at some point lead to a sharp correction. We must defend against such a sudden, dramatic correction,” he said.

The following month, a book was published to expand on the roadmap for the country's economic and social development decided by the 19th Party Congress that included an article (link in Chinese) written by Zhou. He warned of “multi-faceted, hidden, complex, contagious and hazardous” risks accumulating in the financial system that could suddenly erupt, and called on regulators to “take the initiative to prevent systemic risks by accelerating financial reform and opening up.”

Zhou reiterated the need for China to continue down that path during his final press conference at this year's annual meeting of the National People's Congress, and urged the government to “be bolder” in opening up. The PBOC governor has been one of the most popular fixtures at the congress for the last 15 years, retaining his composure and good humor even as he was mobbed by journalists. At packed press conferences he fielded questions that ranged from monetary policy and the exchange rate to cryptocurrencies with patience, courtesy and tact.

This year, however, attention focused on his legacy. But when asked to name his greatest accomplishments and regrets Zhou refused to be drawn, saying only: “I feel very honored to work with all of you to push forward China's financial reform and opening-up.”

Wang Liwei contributed reporting for this article.

Contact reporter Liu Xiao (liuxiao@caixin.com)