China could fully liberalise its interest rate regime as early as July and almost certainly by the year-end, according to money market traders gearing up for the change. The People's Bank of China's (PBOC) earlier this month raised the maximum that banks may set their deposit rates at from the official benchmark to 1.5 times. Unlike in the past, the move went smoothly.
Banks did not panic into raising rates in a battle to attract deposits, signaling they would rather adjust to market conditions and that a slew of recent regulatory reforms such as the relaxing of loan-to-deposit ratio requirements had eased pressure on them. Though a few smaller lenders did raise their rates, suggesting they will be the ones to feel the most competitive pinch from interest rate reforms, traders and analysts still think full liberalisation is imminent.
"The absence of malicious competition among banks after the latest widening of the ceiling has prepared preconditions for the PBOC to fully liberalise deposit rates when it next cuts policy rates," said a senior trader at a Chinese state-owned bank in Beijing. "July is a window because it will be the second anniversary of China's liberalisation of its loan rates in July 2013," he said. "Officials have talked about the possibility of fully freeing deposit rates in about two years from the loan reform."
The May 10 ceiling increase to 1.5 times - from 1.3 times in February and 1.2 percent last November - was the biggest since the PBOC began reforming deposit rates in 2012. But banks' response to the change was muted, with China's biggest seven banks, including top lender Industrial and Commercial Bank of China , keeping their one-year deposit rates around 1.1 times the official benchmark, secondary banks around 1.2 times and smaller banks around 1.4 times.
PBOC officials have also said conditions are ripe for full liberalisation. "Interest rate liberalisation has now entered the last phase," Lu Lei, director of the PBOC's research department, told the central bank's newspaper, the Financial News, on May 11. "Conditions are already mature to fully free the upper limit of deposits rate." If full liberalisation does not come in July, analysts see it happening this year.
"The latest ceiling hike has had little impact on banks' decisions on their own rates, signalling the market is mature for the full rate liberalisation," said Dong Dezhi, chief fixed income analyst at Guosen Securities in Shanghai. "So it's now safe to say that the liberalisation is near completion and is likely to complete this year." The market now wants to know how the PBOC will guide rates in a free interest regime, with most players expecting the central bank to follow the US Federal Reserve's model of using money market rates as guidance rates.
That would mean that banks would set their deposit rates in line with market conditions rather than just raising them without any limits in a bid to attract deposits. Traders are now watching money market rates more closely in the belief that they will become guidance rates soon. They said the PBOC's recent reduction in open market operations - with the bank conducting none over the past month - suggests it is moving to using money market rates as guidance rates rather than as a tool to manage short-term liquidity.
From March up until the PBOC's last rate cut on May 10, the central bank slashed the yields of its seven-day reverse repurchase agreements and successfully guided money market rates lower. "The PBOC's reverse repo yield appears to have been used as the guidance rate for money markets rates," said a trader at a Chinese commercial bank in Shanghai. "Such a method appears to be similar as the US Fed's use of its overnight rate to signal its policy inclinations.