China's interest rate liberalisation may fall short without SOE reform
Until Beijing overhauls its monopolistic state-owned enterprises, central bank efforts at interest rate liberalisation may fall short, warn analysts
For a decade, the central government's annual work reports have paid lip service to deepening reforms of the mainland's interest rate system and its state-owned industries.
This month, People's Bank of China governor Zhou Xiaochuan finally gave a timetable for wrapping up interest rate liberalisation, saying he aimed to get the job done within one or two years.
However, even the most veteran of China watchers cannot say when Beijing will embark on a major overhaul of its monopolistic state-owned enterprises, or indeed whether that day will ever come.
And analysts caution that such reforms are linked to each other, with interest rate reform possibly depending as much on SOE reform as it does on the central bank.
"Simply speeding up interest rate liberalisation without being accompanied with other steps, the road to reform would be full of twists and turns," Citigroup economist Shen Minggao said.
Shen said the odds on Beijing accomplishing deposit rate liberalisation within two years depended partly on whether reform of local governments and SOEs could take place simultaneously.
"Owing to soft budget constraints, they are not sensitive to the cost of capital and thus deposit rate liberalisation may not necessarily generate gains in investment efficiency and allocation efficiency," he said.
The PBOC still caps returns on deposits at banks at 1.1 times its benchmark rate, which is 3 per cent for one-year deposits, but has removed controls on lending rates. The main reason it has refrained from abandoning curbs on deposit rates is concern about the impact on bank profitability.
State-owned banks make about two-thirds of their gross profit from net interest rate margins, while the share for stockholding banks, whose intermediary business is weaker, was as high as 79 per cent at the end of June last year.
When the curbs are lifted, deposit rates are expected to rise as banks would have to offer higher yields in order to compete for clients. Wealth management products and internet finance products now offer higher returns than savings deposits, which have accelerated the pace of rate deregulation.
Lu Ting, an economist with Bank of America Merrill Lynch, said the overall impact on the economy would be positive, because "market-determined interest rates will more efficiently allocate precious capital".
Some privileged SOEs might end up with higher funding costs, Lu said, but mainland savers would see a jump in the returns on their deposits.
Ideally, intensified competition would prompt banks to chase higher risks, such as through lending to small and medium-sized enterprises, or gearing up investment in bonds and derivatives to offset the decline in net interest rate margin.
However, analysts say any improvement in the effectiveness of capital allocation would depend largely on progress in SOE reform, which has so far been slow.
Everbright Securities chief economist Xu Gao said the time was not yet ripe for full liberalisation of interest rates, "given the lack of progress in market-oriented reform on the borrowers' side, such as local governments".
"Local authorities' financing activities remained robust despite high interest rates in the past year," he said. "The authorities had no other better solution but to curb the overall credit supply, forcing private enterprises to bear the rising costs."
Zhang Tianren, the chairman of Tianneng Group, which makes batteries, among other products, said the financing environment for private enterprises "remained challenging".
"The government should further open industries to competition," Zhang said. "Currently, either the state-dominated sectors are still off-limits to private capital, or the threshold is too high. Such reforms would hardly reach the desired goals."
He said private investors continued to face disadvantages in obtaining resources ranging from land to power and finance.
President Xi Jinping said this month that deepening SOE reform was a "big issue" for the leadership.
"The strength of SOEs cannot be trimmed. Instead, it needs to be strengthened," Xi told National People's Congress deputies at the legislature's annual session.
While Xi did not elaborate on how SOEs could get stronger, researchers say Beijing has yet to show strong willingness to overhaul the state sector.
"Policymakers are moving to encourage private investors to play a larger role in China's state sector," said Julian Evans-Pritchard at Capital Economics. "However, unless the government is willing to relax control over state firms, investors will have little power to influence management decisions and therefore the performance of the sector as a whole.
"The government still seems ambivalent about how it wants the state sector to develop."