ASSESSMENTS

China's Necessary Interest Rate Reforms

May 24, 2012 | 10:02 GMT

China's Necessary Interest Rate Reforms
The Bank of China headquarters in Beijing

GOH CHAI HIN/AFP/Getty Images

Summary

A senior financial policy adviser to China's State Council, the country's main administrative body, wrote an article posted May 22 on a government website saying China may begin reforming its interest rate system by the end of 2012. According to the article, the reforms would give banks more freedom to set their own interest rates, allowing them to compete with each other for customers.

Beijing has long acknowledged that some kind of interest rate reform is necessary to boost consumers' purchasing power and make the allocation of capital to private industry more efficient. These are key elements of Beijing's goal of transitioning to a more sustainable economic model. These sorts of reforms would challenge China's politically connected but often inefficient state-owned enterprises (SOEs), which receive financial benefits from the current system.

A move to adjust interest rate policy would indicate that the Communist Party of China (CPC) believes increasing domestic consumption and adjusting the credit disparity between the state and private sector are more pressing needs than protecting inefficient SOEs, at least for the moment. However, like all economic decisions in China, concerns over the political fallout — in this case the consequences of pressing the influential SOEs too hard — will hinder serious reforms.

Beijing must liberalize interest rates as part of a transition to a more sustainable, consumption-driven economic model....

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