Local Government to Blame for China’s Financial Instability: Zhou Xiaochuan


The head of China’s central bank has pointed the finger of reproach at local government for exacerbating the fragility of the country’s financial system.

In an article published on the official website of the People’s Bank of China, Zhou Xiaochuan said that the dogged pursuit of growth at all costs by Chinese local governments has been a key factor behind distorted monetary policy during his term in office.

“All industries and local governments enthusiastically pursued rapid growth and demanded [the central bank] ease money supply,” wrote Zhou.

The ensuing expansion in credit has led to asset price bubbles and associated risk for the financial system, with Zhou previously pointing to the possibility of China’s economy meeting with a “Minsky Moment” collapse.

As asset bubbles have burgeoned, however, market players have only continued to clamour for more liquidity in order to deal with worsening risk.

According to the South China Morning PostZhou have overseen a staggering expansion in China’s M2 money supply during his tenure as central bank governor, with a surge from 18.5 trillion yuan at the end of 2002 to 165.6 trillion yuan (approximately USD$24.95 trillion) as of the end of the third quarter.

In order to address this dilemma Zhou has called for China’s corporate sector to make greater use of equity funding and direct financing in order to reduce their debt levels, as well as culling of the state-owned sector’s zombie enterprises.

Zhou also warned that Chinese regulators will find it difficult to “right the wrongs” created by reckless monetary expansion in time to avert major problems.

Qingdao University economics professor Yi Xianrong said that such frank criticism is highly unusual for a senior official, arriving as it does in the lead up to Zhou’s retirement next year.

The article has been included in the Chinese Communist Party’s compilation of official policy interpretations from the 19th National CCP Congress, implying consensus support for Zhou’s position amongst senior-most leaders.

Yi says it’s unlikely, however, that Zhou’s blunt censure will shift the configuration of Chinese monetary policy in the near term, given that it’s still in the thrall of “the investment impulse of local governments.”

“It’s been that way for a long time and I don’t see signs of change as long as GDP remains key to assessing local officials’ performance,” said Yi to the South China Morning Post.