Monday, October 25, 2004

A reporter asked me some questions about interest rates. Will it rise? Who knows, but I think on a whole it is less costly to raise it now.

Have there really been no changes to China's interest rates for the last
seven years, as has been widely reported? Or just no RISE in interest rates?

I have to look it up, but interest rates have changed on the margin many
times in the past seven years. For example, deposit rate for bank
deposits at the PBOC and relending rates have increased a couple of times
within the last year. The PBOC website should have some information on
that. Some lending rates have also increased recently. When they talk
about interest rate increase now, they are mainly talking about
increasing rate on working capital loans and deposit rates.

Why hasn't the PBOC raised interest rates as they said they would back in
May if the CPI in China went above 5%?

I suspect there is some opposition to that from coastal provinces, which
want to continue a higher pace of investment. In truth, China has seen
inflation much worse than 5%, so technocrats in Beijing thus far have not
had a strong argument for raising interest rates by a lot. Also, the
Ministry of Finance has enjoyed really low interest rates for bond
issuance, so they would vote with the low interest crowd at policy meetings.

Isn't China's effective interest rate at about zero or actually negative
and doesn't this encourage speculative behavior?

Yes, there is negative real interest rate for bank deposits now, and
many depositors are withdrawing money to speculate in the real estate
market. According to the Caijing piece, there has been a loss of
100b from the banking system in the past 6 months from people withdrawing
money from the state banking system. Granted, 100 billion is not a big
deal, but this can explain why fixed assets investment is still
relatively high despite the fact that money supply only grew by 13% in
the last month. In other words, the new investment now is fueled by
withdrawn bank deposits, not bank loans.

Is an interest rate rise imminent?

I am not sure at this point. There are some good reasons to do it, and
some reasons not to do it. As I indicated above, different parts of the
government have different interests. However, now that the central
committee plenum is over, I think they are more likely to raise interest
rates than before. It wouldn't be a huge increase, however. If they do
it, they will raise lending rates for working capital and deposit rates
at about the same magnitude to ensure bank profits.

What would be the negative effects to the economy, if any, if China were
to raise interest rates now?

I don't think it will have much of an impact on the economy if interest
rates were raised by 1 or 2 %. the PBOC has in effect put a quantity
limit on lending already. Raising interest rates will encourage some
depositors to put money back into the banks, but I don't think it will
have an impact of more than a few hundred billion RMB.

How would the banks be affected by a rate rise?

Again, banks will lobby on a higher increase in lending rates than
increase in deposit rates. Usually, they won't get their way, and
lending rates will only rise by just a bit more than deposit rates.
However, given that CCB and BOC plan their IPOs soon, the central
government might be more generous with the banks.

How much freedom do banks have to set interest rates at present? How are
they controlled?

Very little control, the PBOC now sets a band that all banks in China
must adhere to. The band now is, I believe (check this), 50% above the
PBOC rate. In other words, if official rate is 4%, banks can charge up
to 6%. The Chinese government continue its control over interest rates
so that it can use interest rates as a policy tool to benefit various
regions, sectors, and policy areas.

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