Learning from China’s economic philosophy and policy — IX

Another lesson to learn from China is how it has used a differentiated interest rate policy for banking, and other sectors. Here, once again, rather than adopting shock therapy policies, China has adopted ‘gradualism’ in terms of cautious-paced liberalization. Moreover, to support saving, and investment, it did not use totally market-based, short-term interest rate, so as to both protect against any significant level of volatility, and also keep supportive interest rates for investment. For countries like Pakistan, with high investment needs, especially with regard to green, resilience enhancing investment needs, and also where interest payment-related expenditures are a big ticket, and any volatility can significantly affect debt sustainability issues, application of differentiated interest rate could serve as a highly effective policy option for supporting inclusive, green economic growth. Also read: Learning from China’s economic philosophy and policy — VIII Hence, in addition to providing greater predictability and supportive prices for essential economic sectors—including consumption, domestic production, and exports—the ‘dual-track’ pricing mechanism has also helped foster predictable and supportive interest rates for deposits and lending within the banking sector, while market-based interest rates are applied to bond and money markets. In this regard, ‘The handbook of China’s financial system’ pointed out the following: ‘…a unique “dual-tack” system continues to feature the Chinese financial system: The benchmark interest rates (deposit and lending rates) published by the PBC [People’s Bank of China] remain the anchor for interest rate pricing of deposits and loans in the banking sector, while the interest rates in money markets and bond markets are fully market-determined. ’ Also read: Learning from China’s economic philosophy and policy — VII Moreover, the same handbook pointed out with regard to benchmark rates that ‘Interest rate liberalization has been carried out since the late 1990s, culminating in the PBC’s officially abolishing deposit rate ceilings in 2015… However, although bank deposit and lending rates were officially fully liberalized, in reality the central bank still publishes benchmark rates and sets soft ceilings on deposit rates as of 2019. …Commercial banks’ benchmark lending and deposits rates… have been the most talked-about interest rates in China; they have been directly controlled by the PBC… banks still priced off the benchmark deposit and lending rates set by the PBC as of mid-2019, and have had limited scope to raise deposit rates on their…’ Also read: Learning from China’s economic philosophy and policy — VI Apparently, the reason behind limited interest rate liberalization in the banking sector is to allow the government to play a more incentivizing role. Because the banking sector plays a significant role in generating savings and investments, a “dual-track” policy philosophy has been applied to it. Similar to the pricing of goods, this policy is used to maintain greater control over the pricing of capital, as the banking sector is distinctively more important than other sources of finance. Highlighting the immense importance of banking sector in overall finance in China, the same handbook indicated in this regard the following: ‘Banking institutions make up most of China’s financial system… In the 40 years since the beginning of China’s economic reform and opening-up policy, China’s banking industry has made rapid progress and has now established its leading role in the world… Banking institutions have consistently dominated China’s financial system. The banking industry has been the major financial support for substantive economic development throughout the country. The total assets of China’s banking system are enormous; in fact, most of the assets in China’s financial system are concentrated in the banking system…’ Also read: Learning from China’s economic philosophy and policy — V Moreover, this market-based rate is also kept within an implicit corridor to protect against speculation and, in turn, any significant level of volatility. The same handbook pointed out in this regard: ‘To mitigate excessive volatilities in short-term market rate, the PBC introduced an implicit interest rate corridor system. Interest rate corridors are widely used by central banks in advanced economies… This system features two standing facilities that form the upper bound and lower bound of short-term market rates. A credible interest rate corridor can stabilize market expectations of interest rates and eliminate hoarding behaviour of liquidity at a time of market stress, thus reducing the volatility of money market interest rates. Also read: Learning from China’s economic philosophy and policy —IV The PBC introduced such an implicit corridor in 2015, with the standing lending facility (SLF) rate as the upper bound and the interest rate on excess reserves as the lower bound. By “implicit, ” we mean that the PBC did not officially call this attempt a corridor but instead stated that it aimed at “stabilizing short-term interest rates. ” Since then, open market operations and other monetary policy instruments such as SLF were implemented to keep market rates within the upper and lower bounds. Thanks to the corridor system, the volatility of short-term interest rates in China, measured by the coefficient of variations of R007, [‘interbank seven-day repo rate’] declined significantly between 2015 and 2016, to levels close to those in developed markets. ’ Also read: Learning from China’s economic philosophy and policy — III In addition, these limits in terms of floors and ceilings helped in meaningfully checking growth of non-performing loans. The same handbook indicated in this regard: ‘The nonperforming loans (NPLs) ratio came down from a very high level in early 2000 of nearly 40%. The high NPL ratio was one of the reasons for interest rate controls (including floors on lending rates and ceilings on deposit rates), since it ensured sufficient net interest margins (NIM) for banks to remain profitable and absorb loan losses. As the NPL ratio fell, the need for maintaining a high NIM via interest controls also diminished…’ To further enhance the role of supervision with regard to financial sector, China abolished FSDC (Financial Stability and Development Committee) in 2023, and instead its functions were given to the ‘Central Financial Commission’ (CFC) that was supervised by the ‘Central Committee of the Communist Party of China’, which is an even higher decision-making body than SC. This is unlike the lack of regulation of financial, and capital markets, not to mention reducing the overall footprint of the public sector to an overall reactive – rather that public sector pro-actively playing its part in providing an overall sustainable economic environment, forging symbiotic relationship with private sector, and co-creating markets for enhancing productive-, and allocative efficiencies – role, for instance, as ‘fixer’ of market failures, and ‘facilitator’ of private sector strongly advised under the neoliberal school of thought. Also read: Learning from China’s economic philosophy and policy — II As per the article ‘CPC Central Committee’ published by ‘The State Council Information Office of the People’s Republic of China’ it was indicated ‘According to the Constitution of the Communist Party of China (CPC), the highest leading body of the Party is the National Congress and the Central Committee it elects, and all the constituent organizations and members of the Party are subordinate to the CPC National Congress and the Central Committee. When the National Congress is not in session, the Central Committee carries out its resolutions, directs the entire work of the Party and represents the Communist Party of China in its external relations. ’ Also read: Learning from China’s economic philosophy and policy – I While China has rolled back direct control of interest rates by banks, it still continues to indirectly influence interest rate setting by banks of deposit, and lending rates. The same book pointed out in this regard ‘…China’s interest rate liberalization seems to have been completed. In October 2015, The People’s Bank of China lifted its control of bank lending and deposit rates. However, they were still informally subject to the PBC’s window guidance and capped by what was called the banking industry’s “self-discipline. ” Therefore, China’s interest rates remained dual-tracked: fully liberalized bond rates versus under-liberalized bank rates. ’ The State Bank of Pakistan needs to learn from these lessons, and influence interest rate in better supporting the productive- and allocative efficiency needs for more inclusive, resilient, and overall sustainable development. Moreover, this interest rate management will help disincentivize banks to lopsidedly provide loans to the public sector, and appropriately diversify to the better manage the needs of the private sector. More rationalized interest rate spreads will likely not only better support development needs, but likely lower domestic debt related interest payment for both public, and private sectors. In addition, increasing access to loans at lower rate, in turn, will help enhance the inclusivity aspect of finance, to a greater range of borrowers across income groups. (To be continued…) Copyright Business Recorder, 2026

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