Removing chains on deposit rates will free capital for more efficient use
The sweeping structural economic change foreshadowed by Premier Li Keqiang in his work report to the National People's Congress calls for efficient allocation of resources, particularly credit. Key to that is interest-rate reform, a goal set by the government under the 12th five-year plan for 2011-2015. It is good, therefore, that People's Bank of China Governor Zhou Xiaochuan envisages a time frame for the last, vital step - the liberalisation of deposit rates. Speaking on the sidelines of the NPC meeting, Zhou said this was likely to be achieved over the next one or two years.
He cautioned that market interest rates may spike initially if deposit rates were fully relaxed, but competition would restore them to more balanced levels. The prospect of liberalisation and greater volatility in the credit market reflects the more market-oriented tone of the reform agenda. Although Li set an economic growth target of around 7.5 per cent this year, the finance minister and other officials indicated greater tolerance of a lower growth rate. Li deserves credit for resisting lobbying from local authorities for a stimulus package, despite slowing growth. He wants to seize the chance to lay the foundations for economic restructuring. It is, after all, harder to sell the case for restructuring when the economy is booming. Only when it is slowing does it create the incentive to deal with problems such as excess capacity and misallocation of resources.
The other side of the coin is the perception that 7 per cent-plus growth is needed to ensure adequate employment opportunities. How the government strikes a balance between job-creation and painful economic restructuring - needed to sustain job creation in the longer term - will be a key test.
Meanwhile, the mainland loan market has tightened, indicating a slowdown in shadow banking following the near-default of a trust investment product. Although it has removed curbs on lending rates, the PBOC still caps the return on deposits at 1.1 times its benchmark rate, which stands at 3 per cent for one-year deposits. It is the restraint on official deposit rates that has created a huge, unregulated shadow banking sector. With an unattractive official deposit rate, distrust of the stock market and wariness of a property bubble, investors are left with few other options to put their money to work. There is an urgent need for banks to compete properly for funds. Liberalisation of deposit rates would be an important step along the road to China having a free market for capital.