China's central bank has broadened the floating range for lending rates in its latest move to establish a market-orientated interest rate regime.

It also announced a 27-basis point cut, to 1.62 percent as effective on December 21, in the interest rate it pays on excess bank reserves in an effort to "encourage financial institutions to improve the efficiency in fund utilization.''

A broader floating range for interest rates on loans will "help the development of small and medium-sized enterprises and improve employment, help propel the reform of financial institutions, and is conducive to containing usury,'' the People's Bank of China (PBOC) said in a press release on Wednesday.

Starting on January 1, the upper limit of the lending rate range by commercial banks and urban credit co-operatives will be raised to 1.7 times the benchmark rate set by the PBOC, while that by rural credit co-operatives will move up to 2 times that of the central bank's rates.

"I think they are projecting a notion that prices need to reflect supply and demand,'' said Wang Yuanhong, a senior analyst with the State Information Centre.

Borrowing needs, especially from small and medium-sized enterprises, have been strong this year. But the previous floating range had been too narrow to sufficiently reflect lending risks, central bank officials said earlier this month.

Analysts said it is too early to predict the possible impact of a broader floating range on overall credit growth before it becomes clear how banks and businesses react accordingly.

But some commercial banks said the policy actions, especially the reduction in bank reserve interest rate, seems to divert from policy intentions shown in recent months.

The interest rate cut would easily cost any of the four major State-owned commercial banks up to 50 million yuan (US$6 million) in interest incomes per year. That, coupled with greater freedom in pricing loans, spells an encouragement for commercial banks to lend more.

And interest rates on repurchase agreements are expected to fall, enabling smaller commercial banks, many of which had liquidity difficulties in recent months, to borrow cheaper funds to finance their aggressive lending operations.

The rapid loan increases this year have fuelled inflationary concerns, prompting the central bank to raise the bank reserve ratio by 1 percentage point, to 7 percent of total deposits, in September.

M2, the broad measure of money supply, rose by 20.4 percent on a year-on-year basis to 21.64 trillion yuan (US$2.6 trillion) at the end of November, which the central bank noted yesterday as "still on the fast side.''

"Theoretically, the move is stimulative to lending,'' said a senior manager with a state-owned commercial bank. "We are a bit confused as to what they want us to do.''

The current 1.89 percent interest rate on excess bank reserves had constituted an actual lower end for money market interest rates, which analysts say have troubled a central bank mindful of a market-orientated interest rate regime.

(China Daily December 12, 2003)