Zhou Sees China’s Deposit Rates Freed Within 2 Years

China’s central bank Governor Zhou Xiaochuan said deposit rates will be liberalized in one to two years, as the nation expands the role of markets even amid an economic slowdown and risks from a credit boom.

The China Banking Regulatory Commission will allow a trial of five privately-owned banks, Chairman Shang Fulin said at the same press briefing in Beijing today, part of the annual meeting of the National People’s Congress. Recent yuan weakness shows the greater role of market forces, Zhou said.

The depth of any slowdown may test the Communist Party leadership’s commitment to remaking the economy, after manufacturing cooled, exports plunged and credit growth trailed forecasts in February. The nation’s first onshore bond default and the bailout of a high-yield trust product this year have highlighted financial risks that pose a threat to the government’s goal of 7.5 percent expansion.

“China’s government still has the time and space to deal with the risks,” said Li Wei, a Shanghai-based economist for Standard Chartered Plc. “The government will roll out reforms in a gradual way.”

The Shanghai Composite Index rose 0.3 percent at the 11:30 a.m. local-time break, rebounding from yesterday’s 2.9 percent decline, the biggest drop since June. The yuan strengthened 0.06 percent to 6.1351 per dollar. It fell by a record 1.4 percent last month.

Medium Term

Asked about the drop in the yuan, Zhou said that from the central bank’s perspective, “we focus more on the medium-term trend, and the short-term trend doesn’t necessarily represent the medium-term one.” Recent movements in the yuan are “very normal and also reflect the growing role of market forces,” he said.

In a Bloomberg News poll of economists last year, a majority predicted policy makers would remove all restrictions on deposit rates in 2016 or later. Zhou’s comments today suggest 2015 or 2016.

“This is much faster than we had expected,” said Dariusz Kowalczyk, a Hong Kong-based strategist at Credit Agricole CIB. At Bank of America Corp. in Hong Kong, economist Lu Ting said the pace was “broadly in line with our expectations.”

Zhou reiterated interest rates will initially rise as controls are removed, while Shang said that banking risks are under control, adding that lenders have sufficient capital and provisions for non-performing loans.

Alibaba Application

The banking regulator will allow privately owned banks to be set up in the cities of Shanghai and Tianjin and in Guangdong and Zhejiang provinces, Shang said. Alibaba Group Holding Ltd. and China Wanxiang Holding Co. will apply jointly for a license, Alibaba said in an e-mailed statement.

China’s credit growth trailed analysts’ estimates in February, signaling a shadow-banking slowdown following a trust investment product’s near default.

Aggregate financing was 938.7 billion yuan ($153 billion), the People’s Bank of China said yesterday in Beijing, less than the 1.31 trillion yuan median estimate of analysts surveyed by Bloomberg News. New local-currency loans were 644.5 billion yuan, accounting for about 69 percent of aggregate credit, the largest proportion since July.

The Communist Party leadership is trying avoid any repeat of the financial turmoil that occurred in nations from the U.S. to Sweden to South Korea after interest-rate controls were eased.

Floor Removed

China last year removed a floor on what banks can charge for loans. Revamping deposit rates is the “riskiest” part of reforms leading toward full interest rate liberalization, and would carry a “much more profound impact,” the central bank said July 19, when it allowed banks to freely price loans.

Finland, Norway and Sweden liberalized interest rates in the late 1970s and early 1980s without taking steps to regulate lending or tighten monetary policy, eventually resulting in a “full-blown banking crisis,” according to a 2009 paper by IMF researchers. The savings-and-loan crisis in the U.S. also stemmed from regulatory restraint after the government removed deposit-rate controls, the IMF study said.

In South Korea, a partial loosening of limits on interest rates in the 1990s was followed by reckless investment by large companies and a financial crisis, according to the “China 2030” report published in 2012 by the World Bank and the State Council’s Development Research Center in China.

— With assistance by Xin Zhou, and Xiaoqing Pi

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