China will gradually remove the ceiling on deposit rates and the floor on lending rates as the health of its banking system improves, deputy central bank governor Wu Xiaoling said on Saturday.
Wu gave no timetable for liberalisation, but her comments will reinforce speculation that interest rate reform will be a priority for China's leaders when they hold a five-yearly conference in coming weeks to chart financial strategy.
Speaking at a forum on rural finance and development, Wu said the central bank had to maintain deposit and lending limits for now because banks lacked self-discipline.
Without a cap on deposit rates, currently 2.52 percent for 1-year money, banks would lure savers with high rates even if they could not afford them. Similarly, without a floor on lending rates, banks would slash borrowing costs to win business and end up in trouble. "With the mechanism of financial institutions improving, the floor and ceiling will gradually fade out," Wu said.
The People's Bank of China, the central bank, removed the ceiling on lending rates in October 2004 but banks must still charge at least 90 percent of benchmark rates set by the PBOC. For the 1-year tenor, this rate is 6.12 percent.
Wu's comments come ahead of a visit to Beijing next week by a high-powered US delegation led by Treasury Secretary Henry Paulson, who is expected to encourage China for its own good to keep liberalising its financial and product markets.
The International Monetary Fund has also been a strong advocate of letting market forces set the cost of money, saying it would improve the allocation of capital and so help sustain China's rapid economic growth.
Touching on the issue of China's $1 trillion stockpile of foreign currency reserves, Wu issued a stern reminder to politicians that the money belongs to the central bank.
Asked whether it was feasible to use the reserves to fund rural development, she said: "As long as you buy the foreign exchange reserves with yuan, you can do whatever you want with it." She has made similar comments before. Debate has been intensifying in China about how best to use the reserves, which are accumulating rapidly because of China's swelling trade surplus.
One idea gaining currency is to set up a separate agency to manage part of the reserves actively. Bankers assume the bulk of the reserves horde is invested in relatively low-yielding dollar bonds. On rural finance, Wu stressed that banks must be able to charge interest rates that are high enough to compensate them for the additional risk involved.
She said subsidising interest rates merely ensures that money goes to the well-connected or to projects that do not deserve to be financed in the first place. In the same vein, she agreed with Muhammad Yunus, the Nobel Prize-winning pioneer of microcredit in Bangladesh, that lending to rural households and firms must be done on a commercially sustainable basis. China would encourage such lending but would ensure it is managed effectively, Wu said.