Central bank deputy governor looks to more balanced future

Q: The internationalisation of the renminbi is gathering pace. How do you see the development of the renminbi as an international currency and the role of the currency on the global stage in the future? With China’s foreign exchange reserves now nearing $4000bn, do you see the country’s reserves stabilising and what is China’s reserve strategy?

A: The People’s Bank of China [PBoC] prefers to use the more modest term ‘cross-border use’ of the renminbi rather than ‘internationalisation’.

In the past, we didn’t allow renminbi to be used for cross-border trade and investment. ‘Cross-border use’ was only for hard currency. Now the PBoC has removed the restrictions and barriers on using renminbi, thus setting up a level playing field between renminbi and major currencies. I don’t think the monetary authority should promote using renminbi, but would like to see the use of renminbi as a market process, which should be driven by market participants both inside and outside China. If using renminbi can improve efficiency and convenience, it is welcome. The organic growth of offshore renminbi hubs, such as Hong Kong, Singapore and London, is also healthy.

As far as the growth of the nearly $4000bn official reserves is concerned, I have expressed my view that a certain amount of official reserves is necessary, especially for building confidence, but everything has an optimal level. Reserves are a good thing, but if you have too much, it is probably not very good. I am not saying $4000bn is too much. But now, the marginal cost of further increase in reserves is larger than the marginal benefit.

It is very costly to continue to build up the official reserves. I would like to see the figure stabilising at about $4000bn and would not like to see a rapid increase. We would like to have a more balanced balance of payments and do not intend to pursue a current account surplus. We encourage outward direct investment. We want to allow enterprises and households to have more freedom in holding their wealth, inside and outside China, in renminbi and other currencies. China's foreign portfolio should be more diversified in the private sector rather than concentrated in the public sector. I would like to see these happening within five or 10 years.

As regard to the exchange rate, the real effective exchange rate has appreciated by 40% since 2005 and earlier this year we widened the exchange rate band from 1% to 2% and have since seen fluctuations in both directions. For the PBoC, I think it should gradually reduce intervention, and let the exchange rate be determined by demand and supply in the market. I am confident that the renminbi is moving toward a market-oriented exchange rate regime.

Q: China is expected to overtake the US as the world’s largest economy this year according to the latest World Bank comparisons. How do you see this development impacting on China’s role in the world economy and what is its significance?

A: The simple response is that it is overplayed. Even if China by purchasing power parity [PPP] is getting closer to the US, China still has a long distance to go compared to the US economy if you take into account the quality of goods. If you compare the soft environment, the gap is even bigger. To be realistic, whatever the PPP number is, the US is still the largest and most advanced economy by far, in terms of technology, innovation and hi-tech equipment, etc…

Q: China’s economy has been seen to be slowing down and moving towards being consumption driven. How do you see the growth of the Chinese economy going forward and how do you see the role of Chinese monetary policy in that process?

A: The Chinese economy is slowing down to a medium-high growth rate. The average growth rate for China was about 10% in the past decade, which was very high. Looking to the future, we will probably have a growth rate of about 7%, which is a lot lower than 10%, but is still quite high compared with the rest of the world. I think that is healthy and unavoidable.

There are several reasons. The first is the base effect. When you are a very small economy, it is easy to grow at 10%. Right now China is a $9000bn economy and the second largest economy in the world. When you have a large base, growth will naturally slow down. The second factor is the demographic trend. The total labour supply of China has peaked at 940 million, probably about 2010-11. In 2012 the labour force declined to 937 million and we forecast that by 2020 the total labour force will be about 920 million.

During the rapid growth period of 1980 to 2010, we had a so-called ‘demographic dividend’ – the economy grew at a rapid rate because of the reform and open-door policy but also because of the demographic dividend. From now on, the demographic trend will have deep implications for growth.

The third factor is that environmental protection and energy efficiency will also be more important and we have to emphasise the quality of growth going forward. We need to have sustainable growth and improve the quality of air, water and soil. We want to have the right amount of growth and improve the environment.

We have significant damage from past low-quality growth at the expense of the environment. That growth path was not sustainable any more. Our environmental capacity is close to its limit, and we cannot further pollute our environment. So if you combine all the above considerations, to have about 7% growth for the foreseeable future is both healthy and necessary.

Q: How do you view the current performance of the Chinese banking sector? What are the key challenges for banks going forward and what developments and changes do you see taking place in the banks in the future?

A: The overall performance of the Chinese banking sector is good. China has started to implement Basel III on schedule, both in terms of capital adequacy and liquidity requirements. In fact, we have a slightly higher standard than Basel III and a slightly faster implementation schedule. We began implementing Basel III capital requirements in 2013 and we should be able to fulfil the requirement by 2017 or 2018, or even a little ahead [of that].

China’s banking sector is probably the most profitable in the world, but this was not the case 15 or 20 years ago when Chinese banks were in bad shape. In the 1990s, I was in the monetary policy department at the PBoC, which was at the centre of bank reform and bank recapitalisation as well as dealing with defaults and non-performing loans [NPLs] of that period.

Overall, my conclusion is that the banking reform, including opening up competition and being listed in the capital markets, was very correct. I must add that I am grateful for the international joint efforts through the Basel Committee, the Financial Stability Board, the International Monetary Fund (IMF) and G20 in discussing financial stability and financial reform issues after the crisis, in which we learnt a lot. We are willing to implement a lot of international measures and that, in part, explains why the Chinese banking sector is healthy.

In the past year or so, the level of NPLs in the Chinese banking sector has slightly increased to about 1%. This is a warning sign, of which we have to take notice. There are a lot of reasons to doubt this 1% figure and much depends on expectations, level of growth and prices, and it also depends on how we handle the real estate market, shadow banking and trust funds. These are all connected, which means that in the future if the above factors developed in the risky direction, it might prove risky for the banks. The current NPL ratio is 1%, but we have to be highly alert about developments in the banking sector and be very vigilant and very careful in terms of regulatory policy and monetary policy.

Q: The shadow banking sector appears to be expanding and becoming a critical part of the overall financial sector. How does the PBoC see it?

A: Everything has a good and a bad side. Shadow banking has some positive elements in it; it introduces more competition, introduces some private capital into the financial sector, fills some empty spots, provides some financial services and helps resource allocation. That is the good side. Chinese shadow banking is different from that in Western countries. In the US and Europe, shadow banking is done through money market mechanisms, securitisation and highly leveraged funds, while in China it is very different and is mostly concentrated in trust funds, which have been partly regulated by the banking and security regulators. Also Chinese shadow banking has low leverage as opposed to high leverage.

Q: Does the PBoC see debt servicing by local governments as a threat to financial stability as the IMF suggested recently?

A: Local government debt servicing is still under control. However, I want to emphasise that the government and the central bank should not be responsible for everything, we should allow default while safeguarding the whole economy against systemic risk. The government and central bank not allowing any default is not good. We all should watch out for moral hazard.