China may be set to replace central bank chief

With China's economy hitting turbulence, Premier Li Keqiang may be set to replace long-time central bank chief Zhou Xiaochuan, a move that could undermine efforts to reform the nation's financial system.

The Wall Street Journal, citing unnamed sources within the Communist Party, reported the possible change on Wednesday. Zhou's removal would be a setback for defeat for one of Li's primary goals: making China's economy more market-oriented.

Li appointed Zhou appointed to a third term as governor of the People's Bank of China just last year despite the latter having passed retirement age. Since then, Zhou has continued to push for a number of market reforms. One such goal is liberalizing deposit interest rates, now capped at 3.3 percent, by the spring of 2016 in order to put more money in consumers' pockets, while increasing competition among big state-owned banks.

This move is opposed by China's banks, which would see their costs rise and profit margins shrink, and by people within the government concerned it could lead to tighter credit. That would further hobble an economy already struggling to meet the government's target of 7.5 percent annual growth.

Although China's economy is believed to be growing at an annual rate around 7 percent, far faster than any of the world's developed nations, even a modest slowdown could have a big impact.

The nation offers little in the way of unemployment insurance or other social "safety net" services. So even a slight rise in joblessness can cause enormous public unhappiness, something Chinese leaders are very eager to avoid. The government has even reportedly paid companies to keep workers on the payroll even though there is nothing for them to do.

China's ongoing economic slowdown is only fueling such concerns. In August, the country's industrial output rose 6.9 percent, the weakest pace in nearly six years, while power generation -- a measure of demand from major industrial users -- fell 2.2 percent, the first decline in four years. Although retail sales were up nearly 12 percent last month, this was down slightly from July. Notably, car sales grew only 4 percent in August, down from 6 percent in July and well off the double-digit growth at the start of the year.

Carl Weinberg, chief economist for High Frequency Economics, thinks vehicle sales may have been off because of the Bank of China's decision to tighten credit.

"The bigger problem is that auto production was not cut back to match," he said in a note to investors. "While direct data are not available, we estimate that inventories of unsold vehicles soared over the summer. Cumulative excess production doubled from 9 million vehicles in January to 18 million in May, and then increased again to 27 million in August."

Weinberg believes much of the August drop in industrial production could be related to a slowdown in auto production and could pick back up once current excess inventory is sold.

Yet much of the broader decline in consumer demand appears linked to the accelerating slowdown in China's property market. Real estate investment for August showed further declines in sales and new construction, while growth in sales of housing-related goods also slowed. This is because of mortgage issuance in the first eight months fell 4.5 percent from a year earlier, worse than a 3.7 percent drop from January to July. There are reports of long delays in getting loans, possibly another result of the central bank's policies.

Real estate remains the biggest economic challenge for Beijing. The soaring property prices in China's biggest cities in recent years, including Beijing, Shanghai and Shenzhen, have since spread to smaller cities such as Tianjin, Chengdu and Wuhan. The government has tried to rein in prices by curbing lending, but this has had a secondary impact of slowing other types of economic activity.

Nicholas Consonery of consulting firm Eurasia Group expects that the Chinese government will allow major commercial banks to relax mortgage requirements, but only with a lot of strings attached.

"Beijing will probably allow commercial banks to reduce mandatory down payment requirements for first home buyers from 30 percent... and potentially offer interest rate reductions for first-home buyers as well," he said in a report. "The banks are unlikely to be able to offer any such reduction in down payment rates in first-tier cities and potentially even second-tier cities, where price falls have been more muted and latent investment interest remains strong."

That poses another problem for Beijing: The government's ability to control lending is hampered by the availability of loans in China's vast unregulated financial sector. This system is based on investment trusts, as well as loans from a number of other sources, including family members and even organized crime groups.

"While China has been able to manage a small number of defaults in trust funds and corporate bonds, a more widespread series of private-sector defaults -- potentially associated with a sharp correction in property prices -- could be more damaging," the Reserve Bank of Australia said Wednesday in a new report on China's financial system.

All of which suggests that no matter who heads China's central bank he is unlikely to have as much control over the nation's financial system as he may want.