China eyes new tool to liberalize interest rate

China's central bank is looking to negotiable certificates of deposit (NCDs) as calls for a fully liberalized interest rate grow.

In its quarterly monetary policy report released this week, the People's Bank of China (PBOC), the country's central bank, said it will gradually offer NCDs for enterprises and individuals to facilitate the country's interest rate liberalization in an orderly way.

Economists expect NCDs could be launched as soon as this year as a step to give people more investment options other than the equity and fund markets.

"Since PBOC governor Zhou Xiaochuan said earlier this year that the regulator will completely loosen its control over bank deposits, it is very likely the NCDs will be launched this year," said Lian Ping, chief economist of the Bank of Communications.

Currently, the PBOC still controls the interest rates banks can offer to clients, allowing lenders to float a maximum 10 percent upward from the benchmark interest rates.

However, the inter-bank interest rates and the lending rates have already been fully liberalized, thus forming a so-called interest rate "dual track" system that many observers say benefits commercial banks with protected interest rate margins and harms depositors.

"If NCDs targeting individuals win the go-ahead, it will be an important step forward for China to remove control over interest rates for deposits and let the market decide interest rates," Lian said.

NCDs have proved effective in overcoming hurdles in interest rate liberalization in other countries. For example, the US Federal Reserve began issuing NCDs in 1973, which gradually became the main source of funds for banks in the United States.

The same monetary tool was also used by Japan and the Republic of Korea when they liberalized interest rates in 1979 and 1994, respectively.

The timetable for a fully liberalized interest rate has been set, which will force the early introduction of NCDs, Lian said, adding that a possible roadmap for development of NCDs in China will be "large-denomination and long-term deposits first, with small and short-term deposits later."

The new monetary tool will also offer options other than stocks, funds or wealth management products for Chinese investors.

Chinese have long been looking for investments that offer much higher yields than the benchmark one-year deposit interest rate of 3 percent, as the government introduced restrictions over property purchases and the performance of China's stock markets remained one of the world's weakest for the past two years.

Such a thirst for investment has helped fuel the boom in money funds sold via the Internet and funneled a lot of funds into wealth management products, which are considered part of China's risky "shadow banking" system.

Wang Tao, chief economist of UBS, projected that after NCDs, the central bank will then call off the 10 percent upper limit of long-term deposit interest rates, allowing banks to float freely.

The interest rates of short-term deposits may come as the last to be fully liberalized, Wang said.