Written by Mikael Mattlin.

Zhou Xiaochuan – China’s long-term central bank governor – finally stepped down from his position in the spring 2018, after more than 15 years at the helm of the People’s Bank of China (PBoC). During his long tenure, there had at times been rumours about Zhou’s departure that had proved wrong.

In the end, he served almost as long as Alan Greenspan chaired the U.S. Federal Reserve – an impressive feat in China’s turbulent elite politics. Within the increasingly centralised Chinese system of economic and financial governance, Zhou’s relatively liberal-leaning economic views often stood out. As an unusually prominent character within the Chinese political system, Zhou had some of the “rock star aura” over him that leading central bankers from Alan Greenspan to Mario Draghi have possessed.

Zhou was replaced by his long-term deputy Yi Gang, to some surprise. However, in a move to emphasise party-control over the central bank, one of his tipped successors, Guo Shuqing, was placed above Yi Gang as PBoC party secretary. The PBoC has never been an independent central bank, neither in principle, nor in practice. Yet Zhou’s impressive personality managed to carve out some space for policy initiatives, foremost the drive to internationalise China’s currency, the renminbi (RMB). While both Guo and Yi are also regarded as reformers, the question is whether they now have the high-level backing for bold financial sector reforms.

At the recently concluded Boao Forum, Yi provided a timetable for opening up China’s financial sector to foreign ownership, which again revived hopes for bolder financial reforms and provided new impetus for a globally important renminbi. His first policy move (a surprise after-hours reserve ratio cut for most banks), also gained applause from financial markets for showing creativity and good grasp of financial market operations.

In the background of the PBoC leadership restructuring looms a larger question: can China act as a genuinely globally important central bank in the manner of the Federal Reserve or the European Central Bank (ECB)? An increasingly common view among observers is that China is determined to challenge American economic dominance. Yet, there are major impediments. One hurdle is whether the PBoC will be called upon, and is able, to assume a central role in times of global economic crisis. Given that the PBoC has the biggest balance sheet of all central banks, whatever it does will necessarily have a global impact. By actively supporting domestic growth, the PBoC also indirectly supports a substantial part of global growth. Nevertheless, in the 2007–14 financial and debt crises, the PBoC’s direct crisis-fighting role was still peripheral to the Fed, the ECB, and even to the Bank of Japan.

For a globally important central bank, liquidity provision during financial market stress is central. In the 2008 crisis, Fed-provided liquidity saved not only American commercial and investment banks. The Fed also provided several hundred billions of liquidity swap lines to a wide range of foreign central banks.

Yet, even the most systemically important central banks are still primarily national central banks (or regional, in the case of the ECB). Leadership in cross-national financial crises has tended to emerge more out circumstantial necessity, incrementally and through contingencies rather than by meticulous plan and grand design. The tortuous and often amateurish steps taken by the Roosevelt administration in dealing with the 1930s global economic crisis, are illustrative. Arguably, this was the period when the United States first began acting as a global economic leader. The Fed had been set up only two decades earlier, and had initially been circumscribed by national legal and regulatory constraints, which had enabled London to retain its status as the leading financial centre.

American central bankers have often initially shown reluctance towards getting involved with faraway economic and financial crises. For example, according to the acclaimed Greenspan-biography, Greenspan’s initial response to the Asian economic crisis in 1997–98 seemed to be one of aloof disinterest, fitting with his Randian intellectual roots. From time to time, American central bankers remind the rest of the world that they are the central bank of the United States, not the whole world. Yet time and again when economic crises hit, dollar liquidity shortages tend to quickly emerge, forcing the Fed to provide liquidity swap lines to ward of the financial system freezing up.

China’s financial system has grown massive in size, and some areas have developed well (e.g. the domestic bond market). China has also been actively constructing the infrastructure and “plumbing” for global provision of renminbi liquidity by concluding bilateral swap arrangements with many other central banks. Furthermore, China has taken a proactive role in boosting various multilateral liquidity arrangements, including through the IMF, within the multilateralised Chiang Mai Initiative (between Asian central banks) and the BRICS Contingent Reserve Arrangement (among the BRICS countries).

The Chinese government made internationalising the renminbi a stated policy goal in the 12th five-year plan (2010). Since then, a long list of government initiatives promoting the currency’s wider use have been implemented, e.g. gradually expanding possibilities for renminbi cross-border trade settlement, opening a RMB-denominated bond market in Hong Kong (“dim sum bonds”), establishing RMB-clearing in financial centres, as well as allowing the possibility to make direct overseas investments in renminbi. Yet, international use of the renminbi stalled after 2015, amid the government’s crackdown on financial risks. Currently, China still maintains relatively strict capital controls that have set back the PBoC’s earlier internationalisation drive.

China has been moderately successful in promoting the renminbi as a regional trading currency in Asia, especially in its border trade and trade conducted by Chinese state-owned enterprises. Beijing has also attempted to promote the currency’s use in the pricing and counting of products and goods, taken intermittent steps towards reforming China’s domestic financial system, and creating liquid offshore bond markets. Yet, unless China liberalises its capital account and makes the currency freely convertible, there is scant prospect of truly making the Chinese renminbi widely used. True international currencies have, as a rule, become freely convertible before they became internationalised. Economic theory regards convertibility as a precondition for internationalisation.

Building the global infrastructure for renminbi use can only go so far, if natural international demand is not there. Inclusion of the renminbi in the International Monetary Fund’s SDR basket as of October 2016 implies that central banks ought to boost their renminbi holdings closer to the currency’s share of the SDR basket (10.92 %). Yet, the renminbi share of offical forex reserves stands at scarcely above 1 %. The same picture emerges from Bank for International Settlements data on OTC foreign exchange transactions, where renminbi usage is still below the Swissie, and only a small fraction of the USD.

Numerous financial crises have shown that “what it takes” to be a truly important central bank is to improvise and take bold (and risky) individual initiative when the going gets tough. Greenspan did it during the 1987 stock market collapse (together with some very accomplished officials). Bernanke thought outside-of-the-box in 2008, and Draghi did his famous “whatever it takes” talk to quell the Eurozone debt crisis in 2012. Crucially, in the current Chinese political environment, it is difficult to envision any Chinese central banker being able to pull off a “draghi”, or even a “greenspan”. The Chinese political system is designed for cautious, gradual and well-planned policy-making, and true authority increasingly resides at the very pinnacle of the system, lending any lower-level bold policy initiatives unlikely. Paul Volcker’s shock October 1979 weekend interest rate hike and change to targeting the money supply, while ignoring political constraints, is a tall order even for Western central bankers to match, let alone a PBoC lacking central bank independence.

China is torn between the partly conflicting goals of currency internationalisation and maintaining domestic financial stability. We have yet to witness a financial crisis where there would be a clamour for renminbi rather than the almighty greenback. Recent research on international currencies suggests that, while one currency tends to be the most important, there is space for at least one other currency to play a major role.

However, as long as China’s financial markets lack depth, and Beijing is intent on maintaining capital controls and keeping the PBoC on a tight political leash, chances are that the renminbi will not be this second currency, let alone the leading currency.

Mikael Mattlin is acting Professor of Chinese Studies at the University of Helsinki and also holds a Collegium Researcher position at the Turku Institute for Advanced Studies (TIAS). He is a Non-Resident Fellow at the University of Nottingham China Policy Institute. Image Credit: CC by Wikipedia Commons.