Money-Market Rates and Retail Interest Regulation in China: The Disconnect between Interbank and Retail Credit Conditions
by Nathan Porter and TengTeng Xu
International Monetary Fund
Interest rates in China are composed of a mix of both market-determined interest rates (interbank rates and bond yields) and regulated interest rates (retail lending and deposit
rates), reflecting China’s gradual process of interest rate liberalization. This paper investigates the main drivers of China’s interbank rates by developing a stylized theoretical model of
China’s interbank market and estimating an EGARCH model for seven-day interbank repo rates. Our empirical findings suggest that movements in administered interest rates (part of the
People’s Bank of China’s monetary policy toolkit) are important determinants of market-determined interbank rates, in both levels and volatility. The announcement effects of reserve
requirement changes also influence interbank rates, as well as liquidity injections from open-market operations in recent years. Our results indicate that the regulation of key retail
interest rates influences the behavior of market-determined interbank rates, which may have limited their independence as price signals. Further deposit rate liberalization should allow
short-term interbank rates to play a more effective role as the primary indirect monetary policy tool.
JEL Codes: E43, E52, E58, and C22.
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