(Bloomberg) People’s Bank of China Governor Zhou Xiaochuan has been pursuing a market-based interest-rate system for over a decade. He’s almost done. Now comes the hard part.
From overnight interbank borrowing to long-term bank lending rates, there are no longer restrictions on the price of money in China. The remaining regulatory sanction that banks can’t offer savers rates more than 150 percent of benchmark deposit levels will be lifted by the end of 2015, according to the timetable made public by Zhou himself.
So the rules are now largely in place for credit to flow through the economy based on potential returns. That’s a sharp contrast to the days when Zhou took over the central bank in 2002 when Alan Greenspan was Federal Reserve Chairman and the price and flow of money in China was largely decided by the PBOC. The task now is to translate the new rules to reality.
“Zhou’s interest-rate liberalization push is approaching its end,” said Yao Wei, a China economist at Societe Generale SA based in Paris. “But it’s the beginning of the end, it’s not the end itself.”
Bloated, corruption ridden and debt burdened state-owned enterprises need implicit government guarantees revoked, so banks no longer view them as safer bets than riskier, more nimble private enterprises. Consumers need to be coaxed to borrow and spend more, to fill the gap as investment wanes.
Progress on those fronts is slower.
State Enterprises
“A key element in interest rate liberalization is that market players have to be sensitive to prices,” said Gu Ying, vice president of Asia local market research with JPMorgan Chase & Co. in Hong Kong, who previously worked for the PBOC. “However, state enterprises and local governments are still not very sensitive to prices, and that’s a problem the central bank alone can’t solve.”
Then there’s the capital account — the flow of money across China’s borders. For a truly liberalized interest rate setting, companies and individuals need to be able to move cash more easily, with all the economic volatility that entails.
“A freer interest-rate system can help foster a market-based financial system at home, and this in turn can help capital account opening,” said Zhang Bin, an economist with the Chinese Academy of Social Sciences. “But is China really ready for full capital account opening? The answer will be ’no’ partly because the exchange rate system is not liberalized.”
Zhou has stepped up his push this year. He started a deposit insurance program to protects savers; he’s twice raised a cap on what lenders can pay savers; and this month came certificates of deposit — instruments that allow banks and savers to meet on interest rates independent of PBOC benchmarks.
Long Tenure
Zhou’s tenure spanned the three government administrations of premiers Zhu Rongji, Wen Jiabao and Li Keqiang, the last of whom assumed office in 2013 during a once-a-decade leadership transition. The acceleration of reforms suggest Zhou has “decided to seize the moment” politically, Andrew Batson, China research director at Beijing-based consulting firm Gavekal Dragonomics, wrote on his blog last week.
For China, freer interest rates promise to make savers wealthier, aiding the economy’s transition to a more services and consumer driven economy. Private enterprises will have better access to capital, meaning the most productive forces get the money they need to expand. And wasteful, uneconomic investment by state-backed firms should become less common.
The challenge is to make those potential gains a reality.
“China’s interest-rate liberalization is almost done, but the financial system liberalization is far from over,” Zhang of CASS said. “There are borrowers taking whatever costs because they don’t have to worry about repayment. There are banks making loans on political considerations. And there are other problems. But the progress can’t be denied.”
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