PBOC Braces for the ‘Last Mile’ in Interest Rates Overhaul
China’s monetary-policy makers are making louder noises this year about a long-postponed reform of interest rates.
(Bloomberg) -- China’s monetary-policy makers are making louder noises this year about a long-postponed reform of interest rates that could ultimately see the abolition of the current benchmark.
The goal is to reduce the number of tools that the People’s Bank of China relies on to control the price of money over the short-term, thereby boosting their effectiveness and lowering the cost of funding. Governor Yi Gang has lent his weight to the reform lately, monetary department director Sun Guofeng has called it “urgent”, and PBOC adviser Sheng Songcheng said it’s the “last mile” in an overhaul spanning two decades.
The renewed pressure arises because there’s increasing evidence that the current system isn’t transmitting the intended policy support to the areas that need it as the economy slows. While the rate that banks pay to borrow from each other has declined over the past year amid liquidity injections by the PBOC, the price of credit for small businesses and the private sector remains elevated. Fixing that situation has become a priority for officials from Xi Jinping downward.
China currently has a two-track system for interest rates, in which bank loans are based on the benchmark lending rates, while interbank borrowing and bond yields are more connected to the 7-day reverse repurchase agreement rate. If the two tracks converge, it could eventually enable the PBOC to influence the entire economy and financial markets via the price of its short-term loans, similar to other major central banks.
“The convergence of the two tracks can bring long-term benefits such as forming unified price signals, eliminating market segmentation and letting price take a decisive role in allocating capital,” said Wang Yifeng, a researcher at China Minsheng Banking Corp. in Beijing. "In the nearer term, the unification of lending rates in particular can lower the financing cost to the real economy."
What’s Wrong With the Current System?
The PBOC has been trying to tackle a persistent transmission problem since middle 2018, to make sure that the increased volume of funding translates into more abundant, and cheaper, credit to businesses and households.
Officials have tackled the problem from multiple angles, such as an administrative edict for major banks to increase lending to small firms by 30 percent this year. The PBOC though remains committed to making the price of credit the ultimate lever to control the economy.
While the stimulus has pushed down interbank borrowing costs and the yield on sovereign and municipal notes, interest rate of loans to non-financial enterprises has declined much less and that to households has continued rising.
What Could a New System Look Like?
Policy makers have not spelled out what they think the new framework should look like, leaving investors with a lot of guesswork. There have been some hints though.
Instead of using a single policy rate, the PBOC will more likely have a “policy rate system” that employs a corridor to guide short-term borrowing costs, coupled with longer-tenor instruments like the existing Medium-Term Lending Facility, according to bank official Sun Guofeng.
A reference ‘Loan Prime Rate’ would then, after some improvements, begin to serve as a guide for credit to the economy, he said. By linking the policy rate system to the new LPR, the PBOC could provide a better reference index.
“Benchmark rates are to move closer to market rates under the so-called convergence, meaning the central bank may not necessarily publish a benchmark rate in the future,” Sun said at an event with media in January.
He said the central bank hasn’t set a timetable of when it can expect to complete the design of the new system or introduce it. "While the convergence itself isn’t difficult, it requires the perfection of related policies."
It’s also not clear how such a change would be communicated, although officials have recently made some efforts to improve signaling of oncoming policy changes.
Introducing true market-based interest rates in China is fraught with difficulty, given the outsized role that state-owned enterprises and local governments play. Banks are also less accustomed to pricing risks for different types of borrowers -- evidenced by their traditional reluctance to lend to the private sector.
Nevertheless, Ding Shuang, chief China and North Asia economist at Standard Chartered Bank Ltd in Hong Kong says that it’s likely that the PBOC will announce the phase-out of the one-year benchmark lending and deposit rates this year.
“The decoupling of lending rates from market interest rates is largely seen to be caused by the continued existence and use of the benchmark lending interest rate by most banks in loan pricing,” Ding wrote in a note last month. “Once a new interest rate system is established, the PBOC can more effectively guide funding costs for the real economy.”
To contact Bloomberg News staff for this story: Yinan Zhao in Beijing at yzhao300@bloomberg.net;Heng Xie in Beijing at hxie34@bloomberg.net
To contact the editors responsible for this story: Jeffrey Black at jblack25@bloomberg.net, James Mayger
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With assistance from Bloomberg