Deposit returns China’s next issue

The biggest step yet by China’s new leaders to move the nation’s financial system toward market-set lending rates heightens the focus on what the central bank says is an even tougher reform: lifting restrictions on savers’ returns.

The People’s Bank of China (PBOC) ended a floor on borrowing costs previously set at 30 percent below the benchmark, it said last Friday The limit on mortgage rates will stay to curb property speculation, the PBOC said. Also unchanged was a 10 percent limit on what banks can offer over PBOC-set deposit rates.

Forcing banks to compete for funds would offer consumers more spending power, while undermining the model of state-directed, subsidized credit bequeathed to Premier Li Keqiang, who took office in March. At stake is phasing in reform as the world’s second-largest economy slows and signs emerge of money exiting the country.

“Reducing controls on deposit rates would have a far bigger impact, boosting household income but also raising costs for large borrowers that have become addicted to cheap credit,” said David Loevinger, former U.S. Treasury Department senior coordinator for China affairs and now an emerging-markets analyst at TCW Group in Los Angeles.

The PBOC itself said three days ago that deposit-rate reform is “the most risky” part of liberalization. The central bank currently sets the one-year lending rate at 6 percent, with a one-year deposit rate of 3 percent.

A government July 15 report showed gross domestic product rose 7.5 percent in the second quarter from a year before, extending the longest streak of sub-8 percent expansion in at least two decades.

Separately, PBOC data today gave a sign of capital outflows in June as yuan positions at Chinese financial institutions accumulated from foreign-exchange purchases fell for the first time since November. Outflows may accelerate in the coming months and liquidity will be tighter, said Liu Li-Gang, head of Greater China economics at Australia & New Zealand Banking Group in Hong Kong.

While removing the floor for lending rates offers the prospect for cheaper funding - after a record liquidity squeeze last month - banks haven’t been availing themselves of the leeway they previously had to charge less. In the first quarter of 2013, about 11 percent of bank loans were made below the benchmark rate, and about 64 percent above it, PBOC data show.

The figures indicate last week’s announcement won’t lead to a “meaningful decline” in lending rates, although it may help reduce borrowing costs for some state-owned enterprises who are seen as less risky, UBS economists led by Hong Kong-based Wang Tao said in a Friday note.

Meanwhile, China’s finance minister denied that the world’s second-largest economy was entering a crisis period, adding that he believed growth could even accelerate, as quoted by the official Xinhua news service in an interview.

The report quoted Lou Jiwei, speaking on the sidelines of the G20 conference on Saturday, saying he expected China’s economic growth to end the year at 7.5 percent, the official target rate.

A Xinhua report on July 12 that quoted him saying he expected growth to come in at 7 percent caused brief market confusion, but Xinhua later changed the report to quote him as saying 7.5 percent.

“We see domestic power generation and electricity consumption increased by 4 percent, and the service industry’s usage of electricity increased 8 percent,” Lou said, arguing that the increases showed efforts to shift China’s economy towards services from manufacturing were bearing fruit.

“None of my fellow delegates think China is going to have a hard landing.”

The interview was published late on Saturday, a day after Beijing announced it would remove the floor under bank lending rates in a move to free up interest rates, which planners hope will put China’s economy on a more sustainable growth path.

Lou said China would continue tax reforms to promote growth, in particular by converting sales taxes to value-added taxes, while cutting down on paperwork and application requirements for Chinese businesses.

His views were more mixed on the country’s real estate industry, which regulators and economists fear is distorted by speculation and fuels inflation.

The industry should play a “normal” role in economic development, he said, adding that its place in China’s urbanization project required further study.

Lou said that people talked about rising housing prices, but the industry faced other issues, including surplus housing in some cities and insufficient land supply in others.

“Many developers lack confidence and many buyers are holding back,” he added. “Therefore the State Council needs to continue to research the long-term mechanism of real estate development,” he said in a reference to China’s cabinet.

Bloomberg, Reuters