NPC to vote on reducing interest tax

The National People's Congress is scheduled to decide Friday whether to reduce or remove the tax on interest income, in another attempt by mainland authorities to cool the country's overheated stock market, the China Daily reported.

Tax on interest income stands at 20 percent, but is expected to be cut by at least half, Li Zhikun, an analyst with China Jianyin Investment Securities, told the newspaper.

Canceling the tax would be equivalent to hiking the interest rate by 76.5 basis points, Li said.

However, JPMorgan economist Grace Ng said cancellation of the tax was unlikely. "There is no clear sign that the tax on interest income will be completely eliminated. It's not what the market is expecting either," Ng told The Standard. She called the tax reduction simply a "substitute to an interest rate hike."

A tax reduction would likely prompt mainland investors to stockpile their money in bank savings accounts and curb the surge of liquidity in the stock market. The move would follow previous tightening measures such as raising the benchmark deposit and lending rates, and increasing stamp duty on share trading.

This time, however, the State Council decided to put its tax reduction proposal through the NPC, a switch from its previous practice of surprising the market with abrupt policy changes, which often resulted in much market volatility and public outcry.

"The Chinese government is clearly increasing the transparency of its policymaking process," Ng said, adding that such preemptive measures are deemed useful in managing market expectations and minimizing volatility. "The impact [of tax reduction] should be relatively moderate," she said.

The Shanghai Composite Index, which tracks large-cap A and B shares, has jumped 46.3 percent, or 1,257.95 points, year to date, raising concerns about an asset bubble in the equity market and accelerating inflation.

However, previous tightening measures did not seem to dampen investors' enthusiasm, as reflected by the continued migration of deposits.

Data released by the People's Bank of China showed that total household savings declined sharply by 278.4 billion yuan (HK$285.4 billion), or 9.7 percent, last month. Also, according to a recent report released by Shenyin Wanguo Securities, between May 2006 and April 2007 the Shanghai Composite Index was pushed up one point for every 423 million yuan of household deposit migration into the stock market. In other words, the market had absorbed 61 percent of deposit loss in that period.

If the NPC votes to reduce the tax on interest income, such migration of deposits is expected to slow down.

The Shanghai Composite Index rose 0.82 percent, or 32.29 points, Tuesday to close at 3,973.37.