Macro-economic management on the Mainland

inSight

04 Nov 2004

Macro-economic management on the Mainland

The interest rate increases on the Mainland last week - the first in nine years - will complement the range of administrative measures taken to maintain macro-economic stability.

 

In the circumstances of the Mainland of China, where financial market structures are at an early stage of development, macro-economic management is, to put it mildly, a difficult task. There are, basically, two alternative approaches - the use of administrative measures and the use of market instruments, even though, operating through nascent financial markets, the effectiveness of the latter has yet to be established. But these approaches are not mutually exclusive. They can be used to reinforce each other, as indicated by the recent increase in renminbi interest rate on the Mainland, coming six months after the introduction of the administrative measures at the end of April.

What appeared to me to be of particular interest is the removal of the cap on lending rates. Individual banks are now free to determine lending rates on individual loans. This will be done hopefully on the basis of objective assessments of the credit-worthiness of the borrowers, as clearly encouraged by both the People's Bank of China (PBoC), as central bank, and the China Banking Regulatory Commission (CBRC), as banking supervisor. Such risk-based credit allocation is, I think, the best way to avoid indiscriminate, across-the-board cuts in bank lending, which can be destabilising and may possibly lead to innocent casualties at considerable economic costs. Through the use of differential interest rates in appropriately pricing credit, the policy of differential treatment through "support and suppress", which has been given much emphasis in the context of the implementation of administrative measures, stands a better chance of success. For those of us who are used to relying on the free market, we would, of course, prefer to leave the market, operating through the commercial judgements of the banks, to determine, rather than the government to specify, which activities are to be supported and suppressed. But this assumes that the banks are in a position to make these judgements and the system allows them to do so independently. I am sure this will, in the fullness of time, be the case for the Mainland. But for the time being guidance from the government is probably still necessary.

Banks have also been given freedom to determine, subject to the caps specified by the PBoC, the levels of deposit interest rates. This is also a significant change, in spirit, in that there will be greater freedom for banks to influence funding costs. In practice, however, competition for deposits will mean that deposit interest rates offered will probably be close to the caps. Nevertheless, this arrangement will avoid distressed borrowing by banks, given that many of them are still financially weak.

The next steps in the reform of interest rate on the Mainland will, I hope, be in the direction of further liberalisation. Banks should be given freedom to determine all deposit and lending rates in accordance with their commercial interests. To effect monetary policy, the PBoC needs only to concentrate on a few policy interest rates. These are the existing re-lending rate to the banks, the rediscount rate, the interest rate for reserve deposits that banks hold with the PBoC, and the spectrum of interest rates at which the now quite large pool of PBoC bills are auctioned and traded in the market. There is also a need for rationalisation of all these policy interest rates, in that it is as yet not very clear as to which is the key instrument for monetary management. This will take time, as markets take time to develop and mature, but I am quite optimistic that we shall see further developments on this front.

Meanwhile, with the use of interest rates buttressing the effectiveness of the administrative measures, I can see a greater chance of success in macro-economic adjustment and control on the Mainland. This is good for everybody, not just for the Mainland, but also for Hong Kong and the rest of the world. The maintenance of macro-economic stability, which also supports financial stability, in an economy that is now the seventh largest, and the fourth largest trading partner, in world, is clearly in everybody's interest. The reaction of major financial markets to the interest rate move last week demonstrates the economic and financial importance of the Mainland in the world. And this is increasing rapidly, with high economic growth being sustained and greater trading and economic integration with the rest of the world.

 

Joseph Yam

4 November 2004

 

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