China removes floor on lending rates amid economic slowdown

Cash Crunch

China’s one-year benchmark lending rate has been held at 6% since the last reduction in July 2012. The PBOC last year allowed banks to offer rates as much as 10% above the benchmark set for deposits and let financial institutions offer loans at a discount of 30% below the benchmark lending rate.

The nation’s overnight interbank rate jumped to a record 12.85% on June 20 as the PBOC withheld cash and restricted its communication, spurring speculation policy makers wanted to expose banks using short-term funds too aggressively for longer-term investments.

Today’s actions “will have important meaning in terms of encouraging financial support for economic growth and economic restructuring and upgrading,” the central bank said in its statement.

China didn’t change the deposit-rate cap because such a move would have a “greater formative impact” and higher requirements, the central bank said. It also cited the lack of a deposit-insurance system.

Weak Credit

“We do not think this is a new policy initiative in response to the growth slowdown,” said Zhang Zhiwei, chief China economist at Nomura Holdings Inc. in Hong Kong. “Credit and monetary growth will remain weak” in the second half as the nation goes through a process of deleveraging, he said.

When he took office in March, Li pledged to open the economy to market forces and strip power from the government. He said at the time that the process would be “very painful and even feel like cutting one’s wrist.”

A key Communist Party meeting later this year may tackle reforms to the financial sector, fiscal system, land tenure, prices, income distribution and household registration.

A majority of analysts surveyed by Bloomberg News in March projected China this year would relax or remove the cap on deposit rates or the floor on lending rates. The government said in March it would this year “roll out new measures in promoting interest-rate and exchange-rate liberalization as well as in developing a multilevel capital market.”

Moderate Pace

PBOC Governor Zhou Xiaochuan, who was reappointed in March after a record tenure of 10 years in the job, said in November that changes to the interest-rate system should be made at a “moderate” pace.

“This is not the same as a rate cut and the impact will be very limited,” said Helen Qiao, chief Greater China economist at Morgan Stanley in Hong Kong. “Liquidity conditions are very tight -- we weren’t seeing companies getting funding at anything close to the lower band before this change, so we’re unlikely to see this will induce an immediate drop in rates. Lending costs come down only when funding becomes abundant.”

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