PBOC to allow trading of interest rate forwards in derivatives push

The People's Bank of China said yesterday it would allow trading of interest rate forwards, an important step in letting market forces determine capital costs on the mainland.

A forward rate agreement allows investors and borrowers to determine the interest rate on a loan in advance for a specified period. The PBOC, which published rules on forwards on its website, said trading would take effect on November 1.

'This is a very important step in establishing market-based interest rates, which is critical for eventual liberalisation of the exchange rate,' said Huang Yiping, Citigroup's head of economic research for Asia-Pacific. 'Proper pricing of capital, through market-based interest rates and exchange rates, are necessary conditions for efficient use of capital.'

The PBOC said that the rates set by the two parties under the new trading system must be based on benchmark rates set by the central bank or the benchmark rate used on the interbank market.

The central bank said the trend for market-based rates was 'becoming more obvious' and could 'help ward off risks in short-term loans'. Traders said the forward rates were needed to determine the true market rate.

The mainland has been accelerating efforts to develop an efficient financial derivative market as the nation further integrates its economy with the rest of the world.