Reform of the mainland's interest rate mechanism will be spearheaded in Shanghai's free-trade zone (FTZ) after it received approval to scrap a cap on foreign-exchange deposits. But Beijing threw cold water on financial institutions' hopes for bold liberalisations in the zone, touted as an important test bed for further economic reforms. Banks inside the 28.78 square kilometre FTZ will be allowed to pay corporate and individual clients as much interest as they want from the start of next month on foreign currency deposits worth no more than US$500,000, the People's Bank of China (PBOC) announced yesterday. The lifting of the ceiling on foreign-exchange deposits was described by the central bank as a "significant step" towards implementing a complete, market-based system for setting interest rates. The PBOC said the total value of foreign-currency deposits of US$500,000 or less inside the zone stood at US$1.2 billion. "We are very cautious on implementing the policy and are worried about potential risks," said Zhang Xin, chief of the PBOC's Shanghai branch. "If the pilot reform were to prove unsuccessful, it would deter overall financial liberalisations at the free-trade zone." The central bank now publishes "guided" maximum rates for foreign-exchange deposits of less than US$500,000 around the mainland. The liberalisation in the FTZ will also be a first groundbreaking move to deepen financial reforms in the so-called mini-Hong Kong territory. Charley Zhou, head of sales with KBC Bank's Shanghai branch, said the mainland remained an export-oriented economy and the policy would give exporters more flexibility in managing their money. "It could somewhat help the real economy grow," he said. Last week, the PBOC allowed companies based in the zone to conduct offshore yuan borrowing, nearly a year after Qianhai, an experimental financial zone in Shenzhen, was allowed to do such business. Admitting the new interest rate policy would result in increased flows either across the border or between the zone and the domestic market, Zhang urged banks to carefully monitor their clients' accounts as a way to ward off financial risks. When the central government gave Shanghai the go-ahead to build the mainland's first FTZ in September, it said financial liberalisations including an interest rate mechanism fully driven by market forces and full convertibility of the yuan would be implemented in the zone. Later on, the cabinet led by Premier Li Keqiang made an about-face amid fears of rampant cross-border flows, while appearing to be reluctant to grant the FTZ "offshore" status that would be exempt from regulatory oversight.