Official's Elucidation on China's Reform of Interest Rate Marketization

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Last updated at: (Beijing Time) Friday, August 15, 2003

Official's Elucidation on China's Reform of Interest Rate Marketization

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China's reform on the interest rates has been carried on for some ten years. People's Bank of China unfolded the "road map" of the reform this year and put forward the goal for a stable promotion of the reform on the interest rate marketization. Why will China carry out the reform on the marketization? What is the road to follow in the reform? And where does the risk lie?

As a key person who directly takes part in and executes the marketization reform, Dai Gengyou, Director of Department of Monetary Policy, accepts the reporter's exclusive interview and explains in a detailed way the "road map" of China's reform on the marketization of interest rates.

Why does China want to Carry Out the Reform of Interest Rates?

Why does China carry out the reform? Dai said, "it is in order to improve the capital distribution efficiency in the financial market, promote the economic growth and enhance people's welfare."

According to him, after 20 years' reform, the efficiency for the market to distribute resources has been greatly improved, yet the mechanism for forming the price of capital (namely the interest rate) is far less competitive than that of commodities and labor as a whole. And so the distribution efficiency led by the capital is restricted to some extent.

The urgency for the reform is also required by the new challenges that the financial industry is now confronted after China's entry into the WTO. The foreign financial institutions flocked into China, bringing with them a lot of new management methods and new financial tools, which have intensified the difficulty of financial regulation.

Dai Gengyou said, "if we don't carry out the reform on the marketization of our own accord, it's possible to land us in a very passive position, accepting the deformed marketization of interest rate, i.e. recognizing the fait accompli that the interest rates have been liberalized to some extent in the market."

Dai pointed out, "if we still lay a strict hand on the interest rates of Chinese financial enterprises, they will be left in a lurch during the fierce competition in future, as they are lack of the competing experience under the conditions when the interest rates are marketized. This is obviously unfavorable to the stability of China's financial market."

What does the "Road Map" Look Like?

Dai Gengyou said, "the ultimate goal of the marketization reform is to realize the interest rates determined by the market." To put it in particular, the present mechanism will be gradually shifted into a new one in which the interest rates will not be regulated by the orders of the central bank, but directly controlled by monetary tools. And then this will in turn influence the interest rates for deposit and loan of financial enterprises.

However, it requires a long transit period to realize the aforesaid goal, and it is an evolutionary process. So, China's central bank has worked out the "road map" for the reform of interest rates. According to the "road map", the reform will begin with the monetary market, the secondary market before the primary market, the interest rate of foreign currency before the rate of the RMB, the deposit rate before the loan rate, the long-term interest rate before the short-term interest rate. The floating range of the loan interest rate will be widened, and then the loan interest rates will be entirely opened to the market; the interest rates of long-term deposit will be opened first followed with the interest rates of short-term deposit.

As for the reason why the interest rate of foreign currency will be reformed earlier, Dai Gengyou said it is because "the initiative of adjusting the interest rate is not in our hands". To keep a basic balance of capital and in the meanwhile to make the domestic commercial banks engaged in foreign currency business avoid losses it is necessary to follow closely the changing foreign interest rates in the international financial market.

Why is the reform on the interest rate of the deposit earlier than that for the loan? It is because "the difficulty in the marketization of deposit interest rates in view of the practice in the liberalization of interest rates of other countries and the experience China has gained in the marketization of interest rates." In the courses of the liberalization of interest rates of other countries, the goal of liberalization of deposit interest rates was generally realized earlier than that for the loan deposit interest rates. Dai Gengyou said, "the initiative of the competitiveness of the deposit market is held by banks with substantive deposit. If the commercial banks are lack of self-discipline and draw in capital with high interests, it's easy to fall into a vicious competition without enough consideration of the cost."

Where does the risk of the reform lie?

Compared with the price reform of merchandise, the price reform of capital (namely the interest rate) is very different. On the one hand, the global flow of capital is quicker and more convenient and on the other, the commercial banks in modern times have the function of creating credit and can realize the expansion of assets and liabilities at the same time. As the assets ratio of commercial banks is much lower than that of industrial and commercial enterprises, the banking industry is under the threat of a high risk.

To free the capital price is therefore faced with more risks than the price reform for the goods, Dai Gengyou pointed out.

First of all, the commercial banks have to bear the brunt. The major business of Chinese commercial banks is to absorb deposits and provide loans, and the difference between the deposit interest rates and the loan interest rates is their major source of profit (occupying over 95 percent). After the Marketization of interest rates, the market competition among the banks will be turned fiercer with the differences reduced. At the time, the commercial banks will be confronted with the situation in which the difference of interest rate is small on the whole and quite difficult to manage. Dai Gengyou said, "part of the commercial banks, especially some small-and-medium banks, will see a drastic downturn in the market shares of deposit and loan or even be elbowed out of the market with the micro-basis for financial stability to be damaged."

Secondly, the financial macro-control will be implemented under a more instable situation. When the economy turns for better, the commercial banks will possibly increase the loans to meet the market needs whereas, when it declines, it is more likely for them to reduce the loans. Given the condition and in combination with the situation that the central bank can only indirectly control the interest rates, the ability of the central bank to control the macro-financial fluctuation will possibly be weakened. Should all kinds of financial developed tools prop up and the financial trades go astray from the substantial economy, the macro-financial risk will come to increase.

Dai Gengyou said, "in view of the international experience, risk is an objective existence in the reform of the interest rate. If we are a little careless, the economy will be in turmoil for a long time and on a large scale, or even the loss of national currency and economical sovereignty." So, he emphasized, "Should serious warps occur in the reform of interest rates, the economical turbulence, especially the financial turbulence will be many more times serious than what happened in some small countries, and the influence on the national economy will likewise be many times as greater."

By PD Online Staff Liu Wei

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