Interest Rate Policies for the People s Republic of China: Some Considerations

Transcription

1 Interest Rate Policies for the People s Republic of China: Some Considerations 1.The Objectives of Interest Rate Policies The rate of interest (and its term structure) is an extremely important instrument for macroeconomic control. It can affect the le vels of aggregate savings and investments; it can also affect the levels of savings deposits and loans in the banking system; it can affect the profitability of enterprises; and it can also affect the rate of inflation. Through these intermediate effects, it can ultimately affect the level of real GDP per capita, the level of employment, the rate of growth of real GDP, and the distribution of income. The rate of interest should be selected primarily to insure the achievement of the most rapid but at the same time sustainable and stable rate of economic growth. The effectiveness of the rate of interest instrument depends on the breadth and depth of the market for (government) debt securities such as Treasury bonds, notes and bills, as well as the responsiveness of the economic agents to economic incentives. The more marketized the economy, and the closer the economic agents to behaving in utility- and profit-maximizing ways, the more sensitive the economy will be to changes in the rates of interest. 2.Rates of Interest on Renminbi Deposits and Foreign Currency Deposits There are two types of deposits in domestic Chinese banks--deposits in terms of Renminbi and deposits in terms of a foreign currency. The foreign currency deposits may be further distinguished between institutional and household deposits. The institutional deposits are held by enterprises, and originate as the retained part of their foreign exchange receipts, whether transitory, or as part of the 15 percent of their foreign exchange receipts that they have been permitted to retain since October The household deposits originate as transfers and remittances from abroad as well as other foreign exchange earnings and receipts permitted by law. There are therefore two questions: (1) What is the relationship between the rates of interest on foreign-currency deposits in China and the rates of interest on the same-currency deposits abroad? Since capital control does not apply to foreign-currency deposits, there is no question that the rates of interest in China must follow those abroad, perhaps with a time lag. However, they do not have to be the same. The interesting question is: what kind of a spread, or gap, is permissible? (2) What is the relationship between the rates of interest on domestic Renminbi deposits and domestic foreign-currency deposits? expected changes in the exchange rate; risk premium; expected changes in the exchange rate=relative changes in the rates of inflation. The importance of transactions costs (two ways); risk premium; variability of the exchange rate; the numeraire currency is considered to be riskless by domestic citizens, tax considerations. Empirical facts:

2 Interest Rate Differential of Different Currencies Compared with US$ (1 Year Deposit) Percent per annum 10 HONG KONG-US MALAYSIA -US 8 EURO-US JAPAN -US 6 TAIWAN-US China-US 4 SINGAPORE-US 2 0 1/1/96 7/17/96 1/31/97 8/17/97 3/3/98 9/17/98 4/3/99 10/18/99 5/3/00 11/17/

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6 Rates of Inflation of Different Countries/Regions (CPI Change Y-o-Y) 12 8 CHINA,P.R.: MAINLAND UNITED STATES EURO ZONE TAIWAN CHINA,P.R.:HONG KONG MALAYSIA JAPAN SINGAPORE Percent per annum M1 1996M7 1997M1 1997M7 1998M1 1998M7 1999M1 1999M7 2000M1 2000M7-4 -8

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8 The Relationships Among Interest Rate Differentials and Inflation Differentials from United States and Exchange Rate Changes (China) 8 6 Interest Rate Differential from US (3-month) Interest Rate Differential from US (1-year) Inflation Differential from US (CPI, Y-o-Y) Rate of Change of Exchange Rate per US$ (M-o-M) Percent per annum Jan- 96 Jun- 96 Nov- 96 Apr- 97 Sep- 97 Interest Rate Differential (US$) (3-month) Interest Rate Differential (US$) (1-year) Interest Rate Differential (US$) (1-month) Feb- 98 Jul- 98 Dec- 98 May- 99 Oct- 99 Mar- 00 Aug Month -6

9 The Relationships Among Interest Rate Differentials and Inflation Differentials from United States and Exchange Rate Changes (Malaysia) Interest Rate Differential from US (3-month) 15 Interest Rate Differential from US (1-year) Interest Rate Differential from US (1-month) Percent per annum 5-5 Jan- 96 Jun- 96 Nov- 96 Apr- 97 Sep- 97 Feb- 98 Jul- 98 Dec- 98 Inflation Differential from US (CPI, Y-o-Y) Rate of Change of Exchange Rate per US$ (M-o-M) May- 99 Oct- 99 Mar- 00 Aug- 00 Month -15

10 This can be anything. but even in countries without capital control, they do not coincide, e.g. Japan, and Singapore and also Hong Kong with its fixed peg. 4.The Role of Capital Control Capital control is precisely what allows a differential in the rate of interest. Control over capital outflow, not over capital inflow. Control over interest rate arbitrage--careful monitoring of borrowing and lending; required repatriation of export proceeds and other foreign exchange earnings Loans to be prevented: non-current account transactions related foreign currency loans secured by Renminbi deposits Foreign currency loans must have a foreign currency source of repayment Interest rate competition--unhealthy competition for deposits should be discouraged. Monitored by the People s Bank. Moral hazard of offering too high a rate of interest on deposits; implicit deposit insurance. Monopolistic powers It is also of interest to compare the spreads, if any, between the same currency deposits in different countries/regions. In the following charts we have plotted the spreads between the rates of interest on Eurodollar deposits and US$ deposits in the United States, as well as the spreads between the rates of interest on Euroyen deposits and Yen deposits in Japan. These spreads are definitely not zero. Moreover, they do not seem to necessarily favor or disfavor the home country. The Eurodollar rates were higher than the rates in the United States for quite a few years, and then the spreads collapsed around the middle of this year. We believe these spreads were driven by the supply and demand for U.S. dollars in Europe for capital flow purposes. The one-month Euroyen rate currently has a negative spread vis-a-vis the onemonth Yen deposit rate in Japan, although the longer-maturity deposits have positive spreads. Our view is that there is little demand for short-term Yen loans, in spite of their low rates of interest, because of the high volatility of the Yen exchange rate. Longer-maturity Yen loans are somewhat more attractive.

11 1.2 Interest Rate Differentials between Euro$ and US$ Differential between Euro$ and US$ Deposit Rates (1-month) Differential between Euro$ and US$ Deposit Rates (3-month) Percent per annum /1/96 6/27/96 12/22/96 6/18/97 12/13/97 6/9/98 12/4/98 5/31/99 11/25/99 5/21/00 11/15/00-0.2

12 1.2 1 Interest Rate Differentials between Euroyen and Yen Differential between Euroyen and Yen Deposit Rates (1-month) Differential between Euroyen and Yen Deposit Rates (3-month) Differential between Euroyen and Yen Deposit Rates (1-year) 0.8 Percent per annum /1/96 6/27/96 12/22/96 6/18/97 12/13/97 6/9/98 12/4/98 5/31/99 11/25/99 5/21/00 11/15/

13 The conclusion of this line of reasoning is that the rates of interest on US$ deposits in China can be either higher or lower than the comparable rates of interest on deposits in the United States, depending on supply and demand conditions in China. Currently, there is an excess supply of US$ deposits in China relative to the US$ loan demand in China (see Chart). Moreover, more than half of the US$ deposits are held by households, which are motivated not only by the rates of interest, but also by considerations of convenience (transactions cost), service, safety and taxation. Many of the institutional depositors (Chinese enterprises) are, at least under current rules and regulations, captive customers (although this situation may change as a result of Chinese accession to the WTO). This suggests that the current policy of maintaining a negative spread between the rates of interest on US$ deposits in China and US$ deposits in the United States is basically correct. What needs to be further studied is how sensitive these US$ depositors in China, both institutions and households, can be to changes in the rates of interest. Their interest rate sensitivity will determine the optimal spread between the US$ deposit rates in China and US$ deposits in the United States.

14 Foreign Currency Deposits and Loans in China Total Deposit Total Loans Billion US$ Month

15 Foreign Currency Deposits in China Institutional Deposits Household Savings Billion US$

16 5.The Impact of Chinese Accession to the World Trade Organization (WTO) Moreover, it is definitely not the case that when foreign banks enter the Chinese market, it is automatically no longer possible to enforce capital controls in China. In fact, all banks, including foreign ones, must continue to comply with Chinese laws. Even U.S. banks have an incentive to keep the rates of interest low. However, rules can no longer be applied in a discriminatory way. 3.Rates of Interest on Renminbi Loans and Foreign Currency Loans Reduction of leverage on loans as opposed to the spread 6.How to Deal with Excess Foreign Exchange Reserves? The excess foreign exchange reserves sold by the exporters may need to be sterilized if it leads to an overissuance of money supply. The excess foreign exchange reserves can be offset through an accelerated repayment of the foreign debt, especially the short-term foreign debt by Chinese enterprises. This may actually be profitable as the domestic rates of interest is lower than the rate of interest in foreign markets. Allow the introduction of Chinese Depositary Receipts (CDR) of large multi-national corporations. Encourage foreign direct investment by Chinese enterprises. Permit arbitrage between domestic and foreign depositary receipts markets by Chinese firms. Permit Chinese portfolio investments overseas in terms of closed end funds. Permit the repurchase of B-shares by the Social Security Fund 7.The Relationship with Exchange Rate Policy The benefits of full convertibility of the Renminbi, that is, the lifting of controls on capital outflow, for the Chinese economy are minimal, but the costs and potential risks are huge. Under the current arrangements, both exporters and importers are not constrained in their abilities to sell and buy dollars for Renminbi respectively. Their businesses are actually facilitated by a stable currency. Similarly, direct investors (necessarily long-term) are also not constrained in their abilities to make investment or to repatriate their profits and principals. And a stable currency suits them just fine. I believe some way will be found to facilitate portfolio investors, e.g., through closed-end funds or through depository receipts traded in foreign currencies. There is thus no really good reason for full convertibility. Capital account restrictions in Japan were not fully removed until the 1980s when Japanese per capita GDP well exceeded US$10,000 in 2000 dollars. Chinese per capita GDP is currently only a little above US$800. It would be at least 2010 when it reaches US$1,500, still a long way from US$10,000, the benchmark for a developed economy. I think if the Renminbi were to trade freely now, it would probably appreciate. However, I doubt that it would appreciate in the same way the Japanese Yen did in the postwar period, going from 360 Yen/US$ to a peak of 80 Yen/US$. The reason is that the Chinese are not likely to be as protective (at least not as effectively protective) as the Japanese. Thus, the large Chinese current account surplus is not likely to persist as it did in Japan's case, especially if the trade in services, always in U.S.'s favor, is taken into

17 account. Moreover, there is likely to be large and growing Chinese net imports of oil, which would further reduce any current account surplus. It is actually in Chinese interest to maintain the exchange rate at approximately its current level. If China lets the Renminbi appreciate, its exports will be hurt. However, if China lets the Renminbi devalue, as is advocated by some in China, it will delay the relocation of industries to the interior from the coastal region, and work against the "Development of the Great West" strategy. The Term Structure of the Interest Rate Differential Recommendations: Keeping the relative inflation low or negative. Equity-Premium puzzle has the same structure as the No-Perfect Arbitrage Puzzle. What one has to ask is: Would someone be willing to borrow Yen in Japan, and convert it into US$ to be deposited/invested in the United States? The answer is No, or at least, not enough to bring the two interest rates together. Transactions cost may have something to do with it. Keeping the transactions cost high will provide some protection in addition to the capital control. 8.3 versus 8.07 Reducing leverage helps to prevent possible turmoil in the market. Risk aversion, thin markets Make a distinction between large and small deposits After the Chinese accession to the WTO and the entry of foreign banks into the Chinese market, it will no longer be possible to require Chinese enterprises to maintain their deposits, whether Renminbi- or foreign-currency- denominated, in Chinese commercial banks. In a crisis, the foreign currency balances held in foreign banks in China by Chinese enterprises and institutions are no longer available to be used to help stabilize the situation if necessary. If foregin exchange can be freely purchased for any legal current account purposes, the rationale for allowing the Chinese enterprises to retain 15 percent of their foreign exchange receipts is no longer applicable. It is proposed that the 15 percent rule be abolished, so that all foreign exchange receipts must be sold to the People s Bank as received. In return, all enterprises will be permitted to purchase foreign exchange from the People s Bank or commercial banks authorized by the People s Bank any legal current-account purposes. However, as a transitional measure, the enterprises with existing foreign-currency balances in their bank accounts currently will be allowed to continue to hold and to spend down these accounts.