The tensions between state control and the forces of supply and demand are on dramatic display in China’s money markets. As the government gradually eases regulations on borrowing costs and deposit rates, the market is plagued by bouts of volatility. The seven-day repurchase rate climbed ahead of the Lunar New Year holiday again in February 2015, prompting the central bank to make its largest cash injections in a year. In January 2014, the rate spiked above 6 percent, leading the People’s Bank of China to pump more than $74 billion into the banking system to relieve funding pressures. In June 2013, it added undisclosed amounts to mitigate the worst cash crunch on record after the seven-day rate surged to 10.77 percent. Some of the turmoil appears intentional: The central bank said in a February 2014 report that the market must tolerate “reasonable rate changes” as a way of “modifying behavior.” China is trying to rein in a credit boom and a shadow finance system that has led to an explosion of risky investment products outside the reach of its regulators. The swings have exposed the fragility of the system and sowed confusion among investors who debate which interest rate really reflects current market conditions, leading to calls for more transparency. The central bank is using a wider array of tools to keep money rates stable — including expanding lending facilities – though it’s not always clear if the steps are intended to calm interbank markets or stimulate the flagging economy.
China’s failure to control interest rates raises the specter of a panic like the turmoil that began in 2007, when money markets seized up in the U.S. and the rest of the world as hidden risks became apparent. While the U.S. Federal Reserve and other central banks were able to intervene to halt the turbulence, they couldn’t prevent the pressures that culminated in the Lehman Brothers bankruptcy and a global recession. China’s buildup of credit has evoked comparisons to Japan’s debt surge before its real estate and stock market bubble burst in the late 1980s. China removed the floor on most lending rates in 2013 and has raised the cap on what banks can pay customers on their deposits three times in three years, a limit the central bank governor says may be eliminated in 2015. Interest-rate liberalization is just one of many fronts where China is balancing the need to expand freedoms while maintaining control. It has allowed more trading of its currency across borders while keeping strict limits on the amount of yuan that can flow out of the country. It takes in more than $100 billion a year in foreign investment while state media attack companies including Starbucks, Apple and Audi for unfair practices, ensuring they know their real master in China is the party, not shareholders.
The debate centers on whether the pace of change is fast enough to defuse the risks of a blowup as economic growth slows to a more sustainable pace of 6 percent or 7 percent. The authorities are well aware that moving too quickly to loosen control of interest rates, or mishandling the process, may spur turmoil. If rates are not freed up, debt could continue to grow unchecked, especially at local governments and other entities. Then there are vested interests like big state-owned banks and companies that resist the changes, which can squeeze their profits and influence. In November 2013, China’s leaders set a 2020 goal to meet the road map for reform. The world will know well before then how serious they are.