Op-Ed Contributors

Liberalize interest rates further

By Xiao Gang (China Daily)
Updated: 2011-01-07 07:40

Liberalization of interest rates can be useful for deepening China's capital markets and improving the monetary policy transmission mechanism. The rapidly growing domestic stock market, debt market and inter-bank market have not only formed a favorable environment for interest rate reform, but are also calling for further interest rate liberalization.

This reform could enable the central bank to make full use of all its monetary policy tools, focusing more on indirect instruments to fine-tune the macro economy. Given that the benchmark rate is influential and a strong signal for other rates, the central bank can improve its policy effectiveness by making stronger intervention on the benchmark rate.

From a long-term perspective, interest rates are, by nature, the "price" of funds and an economic lever, and therefore must be decided basically by market forces. Properly stepping up efforts to liberalize interest rates has become an indispensable part of the development of socialist market economy. It could better shape China's economic structure, correctly reflect money supply and demand, and improve the efficiency of capital allocation and utilization, as well as improve the efficiency of the use of economic and social resources.

Most countries have imposed controls on interest rates for a certain period in their histories, and such controls have played an important part in economic growth and financial stability. But many countries, both developed and developing, have sooner or later embarked on the path of interest rate liberalization after their economies reached a point where marketization needed to be deepened to improve the efficiency of capital use.

Apart from many advantages of liberalizing interest rates, evidence from around the world shows the significant risks to the economy and financial system that this policy can bring. In some countries' cases, interest rate liberalization revealed their banking industries' vulnerabilities and even made some banks go bankrupt. As a result, those countries had to stop their reform, and resume controls on interest rates.

For China, the time has come to accelerate interest rates reform. China's economy has successfully weathered the storm of the global financial crisis and has become an important growth engine for the world economy. Well-combined with market forces and the government's role, macroeconomic management capabilities in China have been strong enough to meet challenges.

Thanks to years of reform and restructuring China's banking sector, less affected by the global financial crisis, has continually improved its ability to grow, laying a solid foundation for future development.

Many banks have also begun to revamp their risk management mechanisms and develop their "universal" banking businesses to be prepared for financial liberalization and disintermediation.

China has successfully followed a wise road map to liberalize interest rates, that is, liberalizing foreign exchange currency rates before yuan rates; liberalizing lending rates before deposits rates.

So far no ceilings have been imposed on lending rates, and almost all rates in the inter-bank market have been liberalized. What we should do next is to gradually let medium- and long-term, large-sum deposit rates fluctuate within certain ranges. It is necessary to raise the low floor for lending rates, too.

As Zhou Xiaochuan, the central bank governor, recently said at a forum, China should let excellent banks enjoy the freedom to be pioneers in further liberalizing interest rates.

There are a lot of things to be done for the reform, and as in other countries, it will take time to realize the goal.

For now, the most important thing is to continue to move in the right direction.