China's central bank governor, Zhou Xiaochuan, has cautioned that low interest rates, especially deposit rates, would remove pressures that force financial institutions to finance the real economy.
"China needs to maintain a certain gap between deposit and lending rates so that banks can profit from providing financing to the economy," Zhou said on Friday at the Business Week CEO Forum in Beijing.
He said unduly low deposit rates would make banks' capital too cheap and put them under less pressure to make returns on that capital by lending.
China's central bank sets floors on lending rates and ceilings on deposit rates. To help the Chinese economy navigate the financial crisis, the central bank cut the interest rate five times in four months between September and December last year, pulling down the one-year benchmark interest rate for loans by 216 basis points, to 5.31 percent, and the rate for deposits by 189 basis points, to 2.25 percent.
"I don't know if it will do good or harm to the financial sector if we make the interest rate even lower," Zhou said.
When interest rates are kept too low, banks concentrate on playing with financial derivatives to seek speculative profits, said Guo Tianyong, a professor of China's banking industry at Central University of Finance and Economics. "And that would create excessive risk-taking in the financial sector.
"I think Governor Zhou's remarks dismissed the possibility of China further lowering its interest rate. Next time, when China makes changes to its interest rate, I'm sure it will make it higher."
The country will also coordinate its interest rate hike with the world's other major economies because a differential between China and other countries, especially the US, might attract money inflows if it is allowed to widen.
The US Federal Reserve pledged this month to keep its benchmark interest rate at a record low for an "extended period" to sustain economic growth.
"The mild outlook for inflation in China means that pressure to raise interest rates is currently quite subdued," said Jing Ulrich, chairman of China Equities and Commodities at JPMorgan. "We believe China will be more likely to tighten monetary policy when the export recovery is on a sounder footing and inflationary pressures are more magnified."
Zhou also warned that China should make wise investments to avoid overcapacity, especially in the manufacturing sector. He said it should also avoid unnecessary infrastructure projects.
Zhou, who was recently named one of the 11 most important Chinese policy makers by Business Week, caused a stir among reporters at Friday's forum.
One reporter fell into a pond and another fell to the ground as they scrambled to quiz him about possible changes in China's monetary and exchange rate policy.