China Removes Floor on Lending Rates as Economy Slows
China eliminated the lower limit on lending rates offered by the nation’s financial institutions as growth slows and authorities expand the role of markets in the world’s second-biggest economy.
The change, effective today, removes a floor set at 30 percent below the current 6 percent benchmark, according to a People’s Bank of China statement yesterday.
While the move temporarily jolted world stocks higher, the PBOC acknowledged that it was a limited step and said that freeing up deposit rates would be more important. The shift came as central bankers and finance ministers from Group of 20 nations gathered in Moscow, and after a cash squeeze in money markets curbed a record expansion in China’s credit.
“While deposit-rate liberalization is still possible, the fact that a decision was made to just remove the lending-rate floor suggests that more aggressive liberalization proposals were defeated, or at least delayed,” said Ken Peng, senior economist at BNP Paribas SA in Beijing. “This decision shows that some reform is being done, but may actually reduce the chances for deposit-rate liberalization in the near term.”
Raising the deposit-rate ceiling would improve household incomes and reduce the attractiveness of non-traditional wealth management products while threatening banks’ profit margins, Peng said.
China is not yet ready for freeing up deposit rates, the “most risky” part of interest-rate liberalization, the PBOC said, adding that the nation lacks a deposit insurance system.
There’s no consensus on deposit-rate reform, Song Guoqing, an academic adviser to the central bank, said today.
“Some people said the timing is right, others said it’s not, there is no unified view,” Song said at a conference in Beijing. “Had there been a unified view, it would have been announced yesterday.”
The change will lower companies’ funding costs and boost financial institutions’ pricing capabilities, the PBOC said. In the first quarter, only about 11 percent of loans were priced below the lending benchmark, according to central bank data.
China will maintain the floor for mortgage rates because the government will continue to curb speculative home buying and investment, the PBOC said. It will remove the cap on lending rates offered by rural cooperatives and also scrap controls on bill discounting rates.
The MSCI World Index of stocks reversed losses immediately after the announcement. It gained 0.2 percent as of market close in New York yesterday. The Bloomberg China-US Equity Index of the most-traded Chinese stocks in the U.S. climbed less than 0.1 percent for a second weekly rally.
China’s economy grew 7.5 percent in the second quarter from a year earlier, down from 7.7 percent in the first three months, and is at risk of the weakest expansion in 23 years. Song estimates growth may slow to 7.4 percent in the July-September period, the third straight quarterly deceleration.
The central bank’s move showed the leadership may be “a bit worried about growth,” Song said, adding that he was giving his personal view. While the government may fine-tune policies, there won’t be a big stimulus, he said.
The government has “full confidence” it will reach its 2013 growth target of 7.5 percent, Zhu Guangyao, a vice finance minister, said today. The central bank’s move was “just one element” of a master plan of the new Chinese leadership encompassing monetary, market and fiscal policies, Zhu said in an interview at the G-20 meeting in Moscow.
Yesterday’s announcement builds on pledges by Premier Li Keqiang to expand an overhaul of interest rates, tagged by the World Bank and the International Monetary Fund as a priority in financial reform.
China’s one-year benchmark lending rate has been held at 6 percent since the last reduction in July 2012. The PBOC last year allowed banks to offer rates as much as 10 percent above the benchmark set for deposits and let financial institutions offer loans at a discount of 30 percent below the benchmark lending rate.
The nation’s overnight interbank rate jumped to a record 12.85 percent on June 20 as the PBOC withheld cash and restricted its communication, spurring speculation policy makers wanted to expose banks using short-term funds too aggressively for longer-term investments.
The latest move “will have important meaning in terms of encouraging financial support for economic growth and economic restructuring and upgrading,” the central bank said.
“This is not the same as a rate cut and the impact will be very limited,” said Helen Qiao, chief Greater China economist at Morgan Stanley in Hong Kong. “Liquidity conditions are very tight -- we weren’t seeing companies getting funding at anything close to the lower band before this change, so we’re unlikely to see this will induce an immediate drop in rates. Lending costs come down only when funding becomes abundant.”
When Li took office in March, he pledged to open the economy to market forces and strip power from the government. He said at the time that the process would be “very painful and even feel like cutting one’s wrist.”
A key Communist Party meeting later this year may tackle reforms to the financial sector, fiscal system, land tenure, prices, income distribution and household registration.
PBOC Governor Zhou Xiaochuan, who was reappointed in March after a record tenure of 10 years in the job, said in November that changes to the interest-rate system should be made at a “moderate” pace.
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