The Standing Committee of the
National People's Congress hold a meeting at the Great Hall of People in
Beijing June 28, 2007. [Xinhua]
China's top legislature Friday gave the State Council the power to
reduce or cancel tax on interest accrued from bank deposits and approved 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
"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.
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.
A pedestrian wallks past a Bank of
China branch in Shanghai May 21, 2007.
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
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
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
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.
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
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
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,