CHINA'S central bank governor Dai Xianglong puzzled foreign bankers this week when he said a unified national interbank money market would be up and running by January 1. How can there be a money market when the key components - free interest rates, a variety of short-term debt instruments, and a robust commercial banking sector - are missing? If a money market as we understand it in Hong Kong is to be set up by the new year, China would have to make a quantum leap forward within the next six weeks to achieve the goal. By all accounts, this is an unrealistic timetable. Foreign bankers said what Mr Dai probably had in mind by January 1 was a rudimentary system where banks were linked to a central bank as well as to one another through a sophisticated computer network. Their direct lending and borrowing activities would be punched into the central computer network, giving the People's Bank of China a more accurate picture of the transactions. This is hardly an interbank money market in the full sense, but is a vital start of what many believe would be a decade-long process of developing a fully fledged one. As China makes the transition from a centrally planned economy to one dictated by the laws of demand and supply, it must have monetary tools for exercising macro-control over the economy. Existing administrative means are inefficient in directing resources to optimal use. Central to the development of these monetary tools is the existence of a fully developed money market. Mr Dai must be aware that such a market cannot develop without removing the lid on interest rates, promoting the widespread use of short-term debt instruments and forcing the four giant state banks to go commercial. Freeing interest rates is a delicate and tricky subject, but the longer the People's Bank delays in tackling it, the longer it will take to harvest the fruits of banking and financial reforms. Interest rates are essentially set by the People's Bank under the guidance of the State Council, which places great weight on the impact of interest rate changes on state enterprises. The rates in China tend to reflect political concerns than the cost of money. As a result, money supply is largely insensitive to interest-rate changes. A rise in lending rates, for instance, does not necessarily lead to a contraction of money supply. There has to be an overhaul in the interest rate system, allowing banks to set their rates according to the demand and supply of money before an efficient money market can be developed. What is less tricky is the promotion of more short-term instruments. Currently, certificates of deposits and repurchase agreements (repos) are used among financial institutions on a small scale. A commercial bills law has been set to come into effect on January 1 to provide the legal framework for greater use of short-term debt instruments. The next stage must be to promote use of instruments such as bankers' acceptances, treasury bills, discount notes, and negotiable certificates of deposits, among the banks. There is little point in operating a money market when the basic elements are lacking or under-used. Big users of these instruments are commercial banks, which are in short supply in China. Much in the way of rhetoric has been heard about commercial banking reforms, but little progress has been made. The four giants - Industrial and Commercial Bank of China, Bank of China, People's Construction Bank of China and the Agricultural Bank of China - continue to be weighed down by bad debts of state enterprises. Superficial signs of reform such as service with a smile are starting to show at these banks, but substantive improvements are slow. This is tied in to the political leaders' extreme caution in slaying the dinosaurs that are the money-bleeding state enterprises. China understandably has to move with caution and restraint when the closure of unprofitable enterprises could trigger massive unemployment. The harsh reality is there is no easy way out. By avoiding the politically unpalatable option of closing them, China only drags down the crucial reforms in the banking and financial reforms. Until the politicians give the right cues, a fully fledged money market in China will have to wait.