China’s Interest-Rate Challenge

NEW YORK – China’s successful transformation from a middle-income country to a modern, high-income country will depend largely on the reforms that the government undertakes over the next decade. Financial reforms should top the agenda, beginning with interest-rate liberalization. But liberalizing interest rates carries both risks and rewards, and will create both winners and losers, so policymakers must be prudent in their approach.

In 2012, the People’s Bank of China allowed commercial banks to float interest rates on deposits upward by 10% from the benchmark, and on bank loans downward by 20%. So, if the PBOC sets the interest rate on one-year deposits at 3%, commercial banks can offer depositors a rate as high as 3.3%. Many analysts viewed this policy, which introduced a small degree of previously non-existent competition among commercial banks, as a sign that China would soon liberalize interest rates further.