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Economy on thin ice with suppressed interest rates

(Global Times)

08:20, July 05, 2012

When the People's Bank of China cut benchmark interest rates by 0.25 percent on June 8, many applauded the decision as a major step toward boosting the faltering domestic economy, even though it would mean pushing the country's real savings interest rate into negative territory as the 3.25 percent one-year deposit rate fell below the 3.5 percent annual growth rate seen in the consumer price index.

Unfortunately, China cannot afford to hold down its interest rates over the long term without seriously jeopardizing its entire economic structure.

For one thing, negative interest rates will only widen the country's already-mammoth income gap. If the government keeps rates below inflation, it is supporting State-owned banks and big businesses at the expense of depositors. The net assets of China's banks exceeded 1 trillion yuan ($158 billion) last year, making them the wealthiest banks in the world - and the central bank's rate cut will only help them get richer as regular citizens watch their savings erode.

Of course, some could lean on the argument that as long as banks are still collecting money, it means that interest rates are not too low - after all, no one forces depositors to put their money into banks. However, given that China still lacks accessible, low-risk investment products, the majority of people in the country have few places to park their money other than banks.

The low interest rates China has maintained over the past several years have also led to over-investment in the country, especially in the real estate sector. In the last two years, real interest rates have hovered somewhere around 2 or 3 percent and cheap financing created a breeding ground for low-efficiency corporate investment. At the same time, low rates led many to funnel their capital into real estate with the expectation that property prices had no where to go but up.

Historically, when interest rates have been positive, real estate investment accounted for 5 percent of China's GDP. However, this figure jumped to 8 percent as peoples' deposits shrank in banks and eventually shot as high as 10 percent last year.

Again, it has been claimed that China's interest rates were cut in response to the loose monetary policy many developed countries adopted in 2009 and in a bid to keep overseas money out of the country.

However, the US reduced rates in order to stimulate its economy through domestic investment - a move that is obviously unsuitable for China, which has already seen an excessive amount of investment growth.

If rates move to a reasonable level, it will stimulate consumption by giving depositors more purchasing power, providing the economy a healthy way to recover.

(The article is compiled by Global Times reporter Qiu Chen based on speeches in Lujiazui Forum that held from June 28 to 30.)

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