Among the range of reform plans set off by president Xi Jinping the liberalization of interest rates is a critical one, writes financial expert Sara Hsu in the Diplomat. It will move China closer to a market-oriented economy.
There are several implications of this expected move. First, it will likely reduce participation in the shadow banking (or non-bank loan financial) sector, which has generated unforeseen risks, since individuals seeking a higher yield have been forced to purchase assets in riskier ventures. Second, it will allow interest rates to be more closely related to market forces and will better reflect the forces of demand and supply for credit. This will likely enhance pricing in the bond market, as market-oriented bank interest rates feed into SHIBOR, the benchmark interest rate given by banks, allowing the bond market to further develop. As a result, reduced segmentation in the bond market may arise. Third, and associated with the second point, the move may in the long run allow the central bank to make greater use of interest rate targeting as a monetary policy tool, rather than using the more costly methods it currently focuses on, such as open market operations and setting the reserve requirement ratio. As interest rates better reflect the demand for and supply of money, they can be used to control liquidity.
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