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I am suspicious that interest rate based monetary policy will work better in China.  (source: Bank of Finland)

Increased use of SHIBOR reflects evolution of China’s money markets.

At the beginning of 2007, China began quoting the Shanghai Interbank Offered Rate (SHIBOR) as part of its financial market reform programme with a view to implementing a market-based interest-rate regime. Official sources say the use of SHIBOR as a reference rate has clearly increased. However, use of SHIBOR varies significantly depending on the instrument and the matur-ity. SHIBOR rates are mainly used at present as a refer-ence rate for contracts of less than three months, which illustrates the actual thinness and underdeveloped state of Chinese financial markets.

By some estimates, use of reference rates has remained lower than hoped, which is evidenced by the grown inter-est rate spreads between different instruments. Currently, the three-month SHIBOR is about one percentage point higher than the rate for central bank bills. The situation may reflect problems in setting reference rates, or it could show that the central bank is using the opportunity to sell its own bills below established market rates. There is essentially no difference between the one-week and overnight SHIBOR and repo rates, which implies that these short-term markets function reasonably well.

The goals of reform of the interest rate regime include increased awareness of interest-rate risk among banks and deepening China’s financial markets. These conditions must be met before China can shift from a monetary policy regime based on regulation of the quantity of money to an interest-rate-based system. China’s long-term goal is a market-based financial system, but the central bank cur-rently imposes strict limits on bank lending and deposit-taking. The general ceiling set by the central bank today for the bank deposit rate (3-month) is 3.33 % and the low-est lending rate (6-month) is 5.91 %.

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