China revives key economic reform

SHANGHAI - Agence France-Presse

Security guards stand outside a branch of the Bank of Communications in Beijing. China’s top five banks said they have raised deposit rates to 3.5 percent. REUTERS photo

China’s move to allow more competition in its state-dominated banking sector revives a reform shelved for nearly a decade and defies expectations of a policy freeze before the leadership change this year.

In what analysts see as a significant step for economic reform, the central bank will allow banks more flexibility to set interest rates, effectively introducing greater competition and improving allocation of capital. Just two months ago, Chinese Premier Wen Jiabao railed against the “monopoly” of big banks, which have reaped healthy profits and funnelled cash to state enterprises while shunning more nimble private firms.

In a policy announcement on June 15-- made along with the first interest rate cut in over three years -- banks can offer a 20 percent discount on loans against a government-set benchmark and a 10 percent premium on deposits. “The People’s Bank of China has resumed its interest rate liberalization process, stalled since 2004,” said Qu Hongbin, co-head of Asian economics research for HSBC in Hong Kong. “This... also implies that Beijing is getting ready to step up its pace of financial reforms.” The change means banks can attract borrowers with cheaper loans while drawing deposits by offering higher interest rates. Previously, lending rates only could float just 10 percent below the set rate.

Change versus stability
Such a reform was not expected to happen ahead of a once-in-a-decade leadership shake-up in the autumn, with expectations the government would avoid change to preserve political and financial stability.

“We didn’t get it until now, when arguably the political background is less certain,” Ken Peng, senior economist at BNP Paribas in Beijing, told AFP. “Generally, people didn’t expect such momentous change until after the 18th Party Congress,” he said, referring to the communist party meeting which will usher in the country’s new leaders.

For years, officials have pledged to further liberalize rates. The last moves date to 2004, when the government removed a ceiling on lending rates and scrapped a floor on deposit rates.