Liquidation Of Public Debt With Financial Repression:the Case Of China

Financial repression refers to any sovereign policy to keep interest rates artificially below the market rate. Typical policies of financial repression, which include interest rate controls, high reserve requirement, government directives on the direction of credit and capital controls, appear all evident in China. As a result, one of the main characteristic of China’s economic rise has been low and often negative real interest rates.This study examines to what extent financial repression has benefitted China’s government by keeping the domestic public sector debt costs down with low interest rates. Keeping interest rates low, other things equal, reduces the governments’interest expenses for a given stock of debt and contributes to deficit reduction. Negative real interest rates not only reduce the interest expense, but liquidate the existing debt in real terms.If financial repression is defined as negative return on savings, it is most evident in China for households. During2003-2012real one year deposit rate for China’s households, adjusted with consumer price index, has been-0.6%. The regression analyses shows low benchmark deposit rates also push down China’s government borrowing costs. The exact savings to the government from financial repression are calculated by the negative real interest rate times the domestic government debt outstanding on years when real interest rates on China’s government debt have been negative. The calculations show that between1998-2012China had six years when real interest rates on government debt were negative (2003,2006,2007,2009,2010and2012). In total China’s government has saved1.706RMB trillion of revenue equivalent from negative real interest rates imposed on these years, which is equal to5.6percent of GDP. In other words financial repression role in liquidating China’s public debt has not been remarkable. But as China’s public debt level continues to rise, government incentives to use financial repression increases. The key policy implications for the future is to keep real interest rates in China’s positive in order to avoid inefficient allocation of capital.