MNI EXCLUSIVE: China Benchmark Interest Rates to Stay For Now

     BEIJING (MNI) - China's benchmark deposit and lending rates will function

as anchors for its credit market for some time, even as the People's Bank of

China pledges to complete market-oriented interest rate reform, sources told

MNI.

     "While the trend is towards the removal of the benchmark interest rates,

for now the country isn't ready," a source familiar with the central bank's

operations said. Traditional rates are still the main guide for lenders when

pricing loans and deposits, and no effective market-oriented replacement is yet

available, the source said.

     Premier Li Keqiang said this month that China will deepen market-based

reform of interest rates. PBOC Governor Yi Gang has said the dual tracks of

money-market rates and benchmark deposit and lending rates will be merged.

     The PBOC has in the last year through its officials and publications

repeatedly emphasized the role of the 7-day interbank repo rate (DR007) as an

important policy rate, and the loan prime rate (LPR) has also been mentioned

increasingly. This led the market to speculate that the traditional benchmark

interest rates will soon be replaced.

     --CHANGE WILL TAKE TIME

     However, sources said the process is complicated and will not occur soon.

Although the PBOC had gradually removed both the ceiling and the floor of the

lending and deposit rates by October 2015, the banking industry's

self-regulatory body still controls the rates to prevent excessive competition.

     Under the self-regulatory mechanism, the rates have to remain within a

range around the PBOC's benchmarks, another source familiar with PBOC operations

said.

     In addition, rate-setting for home mortgages and preferential loans to some

sectors, including state-owned enterprises, also use benchmark rates as an

anchor, the source said. "The pricing capacity of lenders is still weak at

present," the source said.

     Policymakers lack viable alternatives to the benchmarks, the sources said,

adding that DR007 and LPR both have shortcomings.

     Given weak monetary policy transmission and banks' domination of the

finance industry, it is questionable whether the PBOC could achieve its policy

aims by adjusting short-term rates, like DR007, sources said. Market rates are

more volatile than the benchmark rates, which would raise lending costs and

pressure lenders' risk control capabilities, they said.

     As to the loan prime rate, its current formation mechanism is not flexible

enough to meet the demands of policy transmission, sources said.

     The best solution for now may be retaining the benchmark rates and to

mainly depend on adjusting market rates or "window guidance" to reduce real

lending rates, the sources said.

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +86 10 8532 5998; email: william.bi@mni-news.com

--MNI London Bureau; +44 203 865 3829; email: jason.webb@marketnews.com

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