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China frees banks to set their own lending rates

By -BBC | July 23rd 2013

Chinese authorities have given the banking industry greater freedom by allowing banks to set their own lending rates. Previously they were not allowed to lend at rates below a certain level set by the People’s Bank of China (PBOC).

The People’s Bank said it hoped the move would lead to lower costs for companies. It is being seen as a significant part of the government’s plan to make the economy more market-orientated.

“When Chinese President Xi Jinping came to power in March, he promised to reform the country’s economy to encourage more balanced growth,” said BBC Beijing Correspondent Celia Hatton. “The announcement on bank interest rates is the first major change since that time,” she added. Analysts agree that it marks an important development in policy. So banks can lend at lower interest rates than before.

Most observers think they won’t, at least not very much in the immediate future. But the real significance of this move is that it shows the direction China is taking. It is one step towards a more market based financial system.

It is something the IMF has been urging for a long time, most recently earlier this week in its routine annual health check on the Chinese economy. The final destination on this path China is taking is likely to include more open capital markets and exchange rates.

This will be determined by market forces - addressing the long standing allegation that China manipulates its currency to gain a competitive advantage.

Convertible currency

 “It’s a very big deal, probably more in terms of what it symbolises than the effect on the economy,” said Mark Williams, chief Asia economist at Capital Economics. “China has been talking about interest rate liberalisation for a long time, this is one of the biggest steps they could have taken,” he said.

Before this move, Chinese banks had some freedom to lend at rates below the official level, but very few chose to do so.

While it might not have a huge impact on the economy, analysts think the move is an important step towards allowing China’s currency to float freely on the currency markets.

The US has long been calling for that to happen, arguing that China’s currency has been kept artificially low, which gives companies producing there an unfair advantage. “This underlines that China is moving to a fully convertible currency and floating exchange rates “ said Flemming Nielsen, senior analyst at Danske Bank in Copenhagen.

 “Liberalisation of interest rates is a necessary condition for convertible currency and floating rates and their next step will be to widen the daily trading band for renminbi. They should do that within the next three months,” he said.

Chinese steel works China hopes banks will offer lower interest rates to business. There remains an upper limit on how much interest banks are allowed to offer depositors.                    —BBC


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