Interest Rate Liberalization and Monetary Control in China

The end of China's Cultural Revolution in December 1978 heralded a gradual process of economic liberalization and reform. In the financial sector, the monobank system was abandonded in favor of a two-tier banking system in which the People's Bank of China (PBC) became the central bank and its commercial lending activities were transferred to four specialized banks. While China's financial sector has changed since 1978, the credit plan remains the key instrument of monetary policy. Credit ceilings are set for each specialized bank and subceilings are also imposed for specific types of loans, such as working capital and fixed investment loans. Although banks have some discretion in varying interest rates, China's interest rates are basically determined by administrative fiat. Inconsistencies between the development of a market-based economy and the use of credit ceilings as the main instrument of monetary policy have become increasingly apparent. Since 1993, therefore, the Chinese authorities have accelerated the pace of financial sector reforms. Part of these reforms include greater flexibility in, and eventual market determination of, interest rates. This paper addresses some issues raised by prospective interest rate liberalization in China