The People's Bank of China's recent decision to slash the interest rate on postal savings deposits will hopefully help alleviate some persistent problems in the financial sector, but will create short-term difficulties for the postal savings system, analysts said.

The nation's central bank brought the interest rate on funds the postal savings system redeposits at it after August 1 down to 1.89 percent, equal to that on reserves financial institutions deposit at the central bank, from the previous rate of 4.131 percent, it said last week.

That long-awaited decision will probably force new deposits accepted at China's around 20,000 postal savings outlets after August 1 into the market, but the bulk of outstanding postal deposits, estimated at 800 billion yuan (US$96 billion), will remain on the central bank's books, said a bank official who preferred not to be named.

"We have yet to calculate that number (deposits taken after August 1)," he said. "But if it's 800 billion yuan for more than a decade, just one month won't have generated much (deposits)."

In 1986, China's postal system started to accept savings deposits from residents as part of the government's efforts to withdraw excess cash from circulation amid inflationary worries. Such deposits were redeposited at the central bank.

In 1990, the central bank gave the postal savings system greater autonomy over the business and started to pay an interest rate for the redeposited funds that is much higher than that for corresponding regular deposits, both as an encouragement and a compensation for the cost of building more outlets.

An unexpected consequence of that reform, analysts say, was the frenzied enthusiasm generated at China's postal savings outlets, which are widely scattered across the nation's vast rural areas, to collect savings deposits.

Such efforts noticeably reduced funding sources for rural credit co-operatives, which became the main rural lenders after major commercial banks withdrew from the countryside in recent years to refocus on the big cities.

"And the result is that funds in the rural areas dried up," said Li Ruoyu, an analyst with the State Information Centre (SIC).

Li said another defect of the redepositing mechanism of postal savings is that it restricts the central bank's leeway with monetary policy as it has to re-lend the postal deposits, subsequently enlarging base money, the so-called "high energy currency" that amplifies money supply at a far greater pace.

And such deposits have long been a heavy burden on the central bank. Even if it lends all the funds to commercial banks at the highest relending rate - 3.24 percent - the interest spread will translate into 7 billion yuan (US$840 million) in annual losses.

Now the hefty interest rate reduction is expected to help solve all such problems, analysts said, but it will presumably deal a heavy blow to the postal savings system although it won at the same time the right to invest postal savings in a number of ways other than making loans.

"Postal savings account for about one-third of incomes at the postal system. The contribution to profits is even bigger," said Yang Hairong, a professor with the Beijing University of Post and Telecommunications.

The share of income from the postal savings business grew to 35.65 percent of the total postal income last year, compared with 24.6 percent in 1998, statistics indicated.

Officials from the China Postal Savings and Remittance Bureau (CPSRB), which oversees postal savings operations, were not available for comment.

Due to the overwhelming importance of the postal savings business to the postal system, efforts to correct the interest rate problem have long met strong resistance. A widely expected plan to create a postal funds bureau to take over postal savings operations was killed last year.

It is still unknown to what extent the postal system can compensate the huge loss in interest incomes from its investment returns, but the prospect looks gloomy given the low level of yields currently in the interbank market, the major investment venue the central bank has approved.

"They are making preparations but have not come in yet," said a fund manager at a major Chinese commercial bank.

The manager said the arrival of postal savings funds will help alleviate the thirst for funds in the money market, although not in any significant way, because liquidity is fairly tight as the central bank's decision to raise banks' required reserves - to 7 percent from 6 percent previously - took effect yesterday.

Li from the SIC also cautioned about problems that may arise from regulatory overlapping. The CPSRB is under the administration of the State Postal Bureau, but its investments are supervised by the China Banking Regulatory Commission.

(China Daily September 22, 2003)