Signs That a Financial Overhaul May Be in the Works

Beijing announced an important if largely symbolic financial change on Friday. The People’s Bank of China removed the floor on bank lending rates, a move that has been under discussion on and off for decades. The immediate economic impact is likely to be small and possibly mildly stimulative, but it does appear to be a sign that a deeper financial overhaul is in the works.

Removing the ceiling on deposit rates would have a much bigger impact, from hitting bank profits to potentially raising financing costs for some Chinese enterprises to, most important, ending one of the key pillars of financial repression that contributes to China’s stunted consumption.

Changing the deposit rate is much riskier, politically and financially, and we should not be surprised by an incremental approach from the policy makers. Song Guoqing, an academic member of the bank’s monetary policy committee, told the Shanghai Securities News that “no major moves on the deposit rate ceiling should be expected in the near term” given that, among other reasons, China still lacks a deposit insurance program.

The Financial Times reported in its coverage of the bank lending rate move that “the highly symbolic move marked something of a bureaucratic defeat for the central bank, which had hoped to liberalize the ceiling on bank deposit rates at the same time, according to people familiar with the matter.”

The cover story of the July 15 issue of Caixin Magazine discussed the prospects for liberalizing interest rates. The timely article reported, four days before the People’s Bank of China announcement, that:

A source at the research office of the central bank, the government’s official interest rate setter, told Caixin that in the near-term “it’s likely the fluctuation band for borrowing and lending rates can be loosened further” by the government …

Further steps under study could involve lifting the five-year term bank deposit interest rate, which was 4.75 percent in mid-July. Sources said the government is also looking at letting financial institutions for the first time issue certificates of deposit.

These and other steps could ultimately lead to full liberalization for interest rates.

Politics ultimately determine what changes are possible, and there is clearly still resistance to some of the needed changes, though how much is hard to know given the government’s historical preference for incremental reform.

Some observers may argue that any overhaul has come too late to avoid a crash. Paul Krugman, the New York Times columnist, wrote last week in “Hitting China’s Wall” that “the Chinese model is about to hit its Great Wall, and the only question now is just how bad the crash will be. Just the other day we were afraid of the Chinese. Now we’re afraid for them.”

Beijing does not appear to share Mr. Krugman’s concern, at least publicly. The government is trying to project confidence, with several officials in recent days saying that growth remains steady.

Vice Premier Zhang Gaoli said growth was “still within an acceptable range.” Xinhua quoted the finance minister, Lou Jiwei, who was in Moscow for the G-20 finance ministers’ meeting, as saying that “risk of hard landing of China’s economy is not envisaged” by any of the other G-20 participants. In an interview published on Monday, Zhang Liqun, a researcher at the State Council’s Development Research Center, reiterated that China will not have a “hard landing.”

Signs of preparations for more slowing are evident though, as a Xinhua article on Sunday said that growth below 7 percent would “not be tolerated,” while other Chinese new reports held out the possibility of targeted stimulus measures if the country’s G.D.P. growth weakens.

Expert opinion, at least outside of China, appears increasingly convinced that a sharp slowdown in Chinese G.D.P. is inevitable. Michael Pettis argues in Bloomberg opinion article on Monday that “growth will drop to well below 7 percent one way or another,” though he goes on to write that the G.D.P. number should not matter so long as the quality of growth improves.

China’s Internet Muscle

One sector in China that is booming, and contributing to consumption growth, is the Internet. According to the official Internet statistics, China had 591 million Internet users as of June 30, 436 million of whom at least sometimes use a mobile device to access the Internet. China may now have over 200 million smartphone users, more than in the United States. That vast market opportunity is one reason that Baidu is paying $1.9 billion for 91 Wireless, operator of two of China’s largest Android app marketplaces.

Alibaba, China’s largest e-commerce company that also has a growing financial business, is private, but because Yahoo owns a significant stake we get a glimpse of Alibaba’s financial results. According to the recent Yahoo earnings presentation, Alibaba generated revenues of $1.4 billion and earnings of $669 million in the quarter ended March 31. Alibaba is planning an initial public offering, though the timing and location are not publicly known. Hong Kong is probably a more likely venue for the offering than the United States.

Jack Ma, Alibaba’s founder and chairman, generated a firestorm last week with comments he purportedly made to The South China Morning Post about the June 4, 1989, crackdown. He says he was misquoted, and the reporter involved has resigned. Regardless of what he said, investors will likely not care, and Alibaba may end up as the most valuable Chinese Internet company when it finally goes public.