The Standing Committee of the National
People's Congress hold a meeting at the Great Hall of People in
Beijing June 29, 2007. [Xinhua]
China's top legislature Friday passed proposals on authorizing
the State Council to reduce or cancel tax on interest accrued from
bank deposits and proposals on a massive sale of special
T-bonds.
The Standing Committee of the National People's Congress voted
in favor of an income tax law revision that gave the State Council
the power to adjust the interest tax.
"The imposition, suspension or reduction of interest tax on bank
savings, as well as specific methods thereon, are subject to the
decision of the State Council," said the amended law.
Lawmakers also gave the go-ahead for the Ministry of Finance to
issue 1.55 trillion yuan of special treasury bonds to finance the
purchase of foreign exchange reserves for the yet-to-be-established
State Forex Investment Company.
Interest tax
Analysts expect the State Council to initially halve the current
interest tax rate to 10 percent. Should inflation continue to grow,
then the cabinet could cancel the tax completely. However, there
are also calls for the abolition of the tax altogether.
The tax adjustment will be the authorities' latest attempt to
make the real interest rate positive and discourage the diversion
of bank deposits to the stock market.
Currently, the benchmark one-year deposits carry an interest
rate of 3.06 percent. However, given the 20 percent interest tax,
the actual yield is just 2.45 percent.
That return is well below the inflation rate as measured by the
consumer price index, which hit a two-year high of 3.4 percent
after rising 3.0 percent in April and 3.3 percent in March.
If the real interest rate remains negative for a long time, it
will do no good to the economy, said assistant central bank
governor Yi Gang last weekend.
The negative interest rate is encouraging a massive diversion of
bank deposits to the equity market, which has soared 50 percent so
far this year after a 130 rally in 2006.
China's household deposits posted the largest monthly drop in
May, decreasing by 278.4 billion yuan, according to central bank
statistics.
The central bank has raised interest rates twice this year and
is widely expected to announce two more hikes before the end of
year.
China started to collect interest tax in November 1999 in the
wake of the 1997 Asia financial crisis in a bid to boost domestic
consumption. But that aim has largely failed due to the lack of an
eligible social security network in the country.
Bond sales
A pedestrian wallks past a Bank of China branch in Shanghai May
21, 2007. [newsphoto]?
It is still unknown who will buy the special treasury bonds, a
key point in determining the impact of such a large issuance on the
domestic economy.
The ministry could sell the bonds to the central bank in
exchange for the foreign exchange reserves now held on its balance
sheet, with few implications for the economy.
But if the bonds are sold to the inter-bank market, it will take
much longer to raise the funds and will have bigger economic
implications.
The latter case is more likely to happen, China Business News
quoted sources as saying.
Also unknown is the timing of the bond offer. Some predict that
it will kick off in July as the State Forex Investment Company will
complete registration in August and start operations the next
month, according to the newspaper.
On whether the bonds will be sold in one time or in several
batches, the sources expect issuing the bonds in phases, which will
have much smaller impact on the financial market.
In a briefing to the lawmakers on Wednesday, finance minister
Jin Renqing said the special bonds will be tradable and have
maturities of at least 10 years. The market will decide the coupon
rate.
Finance professor Zhong Wei of Beijing Normal University foresaw
a major fluctuation of the financial market caused by the sale,
according to the China Business News report.
The excess reserve rate in the country's banks stands at just
one percent after the central bank ordered the lenders to set aside
more money as reserves, five times so far in 2007, he
explained.
Earlier this year, China decided to set up the State Forex
Investment Company to make more profitable use of its huge forex
reserves which hit US$1.2 trillion by the end of March.
Stock market
News on the possible interest tax adjustment and the bond sale
has affected the stock market for several days.
The benchmark Shanghai Composite Index fell 2.39 percent on
Friday to close at 3,820.70 points, extending a four percent loss
on the previous session. The declines followed a 3.68 percent fall
on Monday and a 3.29 percent drop on last Friday.
Analysts expected the market to remain weak for several days as
the bond sales might soak up money that would otherwise have gone
into stocks. Bank deposits will also become more attractive after
the interest tax is reduced or cancelled.
However, given the widening trade surplus and inflow of foreign
direct investment, the market would continue to experience excess
liquidity.
In addition, even after the cancellation of the interest tax,
the real interest rate is still in negative territory and far below
the return from stocks and mutual funds. Thus the exodus of
deposits is unlikely to stop, analysts said.
(China Daily June 30, 2007)
