By Ehsanul Hoq
Since the trade war, China has changed the lending rate for commercial lenders to keep the borrowing cost at minimum to boost their economy. Experts are expecting that trade war between U.S and China will intensify in coming days. But high borrowing cost is a big problem in financial markets including China, India, Bangladesh and other Asian markets. According to world Bank, Bangladesh and India will grow at 8% and 7% respectively which is a good indication that South Asian economies are moving at a stronger pace. On contrary, China is facing the risk of falling below 6% GDP growth rate in 2020, as U.S tarrifs on Chinese goods are imposed. The International Monetary Fund has predicted 6.2% growth rate for China in 2019 which will be 6% in 2020. The problem is that those forecasts were made before the latest U.S-China trade wars, which will lead to more tariff’s being imposed on Chinese goods in coming months.
To keep the economy in control U.S has single monetary tool- the fed rate. But People’s Bank of China (PBOC) is using multiple methods to keep the money supply and interest rates in control. Loan prime rate is one of those tools. The Loan prime rate is drawn here before the tools used by China are furthered discussed.
Loan Prime Rate
Generally, the prime rate is reserved for banks’ most qualified customers—those who pose the least potential for default risk. Prime rates may not be available to individual borrowers as often as to large corporate entities. Because a bank’s best customers have little chance of defaulting, the bank can charge them a rate that is lower than the rate charged to a customer who has a higher probability of defaulting on a loan. The Loan Prime Rate, introduced on October 2013, was designed to reflect market demand for funds compared to benchmark rates but it failed.
So after getting some basic knowledge on prime rates we can discuss the reforming steps taken by China. Beijing announced the changes will take place from August.
- Commercial Lenders will use Loan prime rates instead of benchmark lending rates.
- The number of financial institutions that are participating in Loan Prime rate (LPR) will be increased.
- Before the change LPR was set on daily basis which will be reformed and will be set on 20th of every month.
- Panel banks will link their LPR quotations to the rate of medium-term lending facilities.
Lower borrowing cost in China
Decline in overall borrowing cost is already evident in China after introducing the new changes. On the first draw the new one-year loan prime rate was set at 4.25% – down from 4.31% previously; while the five-year loan prime rate was fixed at 4.85% – below the five-year benchmark of 4.9%. So theoretically, China will observe lower interest rates on bank loans for business and households.
Ehsanul Hoq is a research associate and freelance content writer/Blogger