China launches market in interest rate forwards

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BEIJING, Oct 8 (Reuters) China will permit trading in interest rate forwards starting on Nov. 1, the latest step towards making its financial markets more market-oriented.

The People's Bank of China said on Monday that it would allow forward rate agreements so that investors would have more tools to hedge against fluctuations in interest rates.

In a statement on its Web site, the central bank said the forward rate agreements would also increase market stability and efficiency and improve the market's price discovery mechanism.

''The launch of forward rate agreements will not only make the range of derivative products richer, giving investors greater flexibility in choosing the proper risk management tools, but they will also provide effective hedging measures for existing interest rate derivatives,'' the central bank said in a statement.

It said the only two derivatives that investors can choose from at the moment are bond forwards and interest rate swaps.

''It's clearly a deepening of the financial markets in China,'' said Glenn Maguire, chief Asia-Pacific economist for Societe Generale in Hong Kong.

But he added: ''I don't think it's signalling a radical departure from the incremental approach we've seen to financial market liberalisation at this stage.'' Lu Zhengwei, an analyst with the Industrial Bank in Shanghai, said the announcement was another step towards market-driven interest rates.

''It is also a must move in liberalising interest rates,'' said Lu, adding traders were in need of such tools to hedge risks and to find out the true market rate.

Forward rate agreements permit investors and borrowers to set the interest rate on a short-term investment or loan in advance for a pre-determined period.

The PBOC said that such contracts would have to be based on benchmark interbank rates or the benchmark rates that the central bank sets for commercial banks.

Beijing has pledged to gradually liberalise interest rates but, as with currency flexibility, it has said that more hedging tools need to be in place first.

Authorities currently maintain a floor on banks' lending rates and a ceiling on deposit rates, citing banks' relative inexperience in pricing risk.

The central bank said that it would gradually introduce other derivative products over time.

REUTERS MP HT1558

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