EXCERPT | China’s Financial Repression Policy

EXCERPT | China’s Financial Repression Policy

By Anqi Lei
Department of Government and Public Administration, University of Macau, China

EXCERPT | China’s Financial Repression Policy

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In the past three decades, China’s 10% annual average economic growth could be largely attributed to financial repression thanks to the low saving rate paid to bank depositors usually failed to match the inflation rate, which made banks to be able to provide cheap loans to state enterprises (SOEs) and infrastructure investment. This has allowed China to rely on savings-financed investments for economic growth and also allowed governments to finance themselves at artificially low-interest rates.

Giovannini & De Melo (1990, [1]) regarded government-imposed controls on domestic financial markets, or the financial repression policies as a form of taxation and it actually made economic liberalization largely stopped at the gates of the financial sector. In China, since 1978 opening reform, although Chinese economy is more open to the world, repression policies are not abolished. As a matter of fact, investment funds are mainly channeled through state-owned banks to state-owned enterprises (SOEs), which then sacrifices many more efficient, small, entrepreneurial and private enterprises.

What’s more, for Chinese households, there are few investment alternatives, stock markets are dominated by SOEs, and it is quite risky and opaque, bond markets are also controlled by the party instead of market-driven, deposit interest rates are set lower than inflation rate primarily by government, the capital flow is controlled and even forbidden strictly. All of these have stimulated Chinese households and enterprises to focus on real estate market expecting for a higher rate of return than other markets. At the same time, financial repression policies also helped fuel an expansion in debt to levels evoking comparisons with the excesses that generated Japan’s lost decade and the Asian financial crisis.

In China, central government adopted financial repression by typically setting nominal interest-rate ceilings that are well below the prevailing rate of inflation and currency depreciation. Table 1 shows the change of consumer price index (CPI) from 2008 to 2015 and Table 2 illustrates the adjustment of RMB deposit rate of Bank of China during the same period.

Table 1: CPI from 2008 to 2015Table 1: CPI from 2008 to 2015

Table 2:  Deposit rate of Bank of China from 2008 to 2015. Source: Bank of China.

Table 2:  Deposit rate of Bank of China from 2008 to 2015. Source: Bank of China.

Apparently, RMB deposit rate always changes with the fluctuation of CPI, but is usually lower than the inflation rate, especially for the demand deposit and short-term time deposit. Peterson Institute [2] measured Chinese repression policy in their report that “the one-year term deposit rate in the first quarter of 2008 was 4.14 percent, an increase of 2.16 percentage points from the rate in February 2002. But that increase is less than a fourth of the increase in the pace of inflation over the same period and has converted a real return of 2.78 percent in 2002 into a real return of -3.86 percent in the first quarter of 2008”.

Borst & Lardy (2015, [3]) even argue that the interest rate established by the People’s Bank of China for the whole banking system actually implies a hidden tax on household savings which equals “more than three times the proceeds from the only tax imposed directly on households―the personal income tax”. According to the calculation of Peterson Institute [2] in their report, “household deposits at the end of the first quarter of 2008 stood at RMB 19.1 trillion while their bank borrowings stood at RMB 5.3 trillion, making their net deposits RMB 13.8 trillion. The estimated implicit tax on these deposits is RMB 255 billion ($36 billion), the equivalent of 4.1 percent of GDP, in the first quarter of 2008”. This implicit tax was actually more than three times the government revenue from the personal income tax which was only 1.3 percent of GDP in 2007.

As we mentioned above, financial repression policies originally come of government-led policy [2] [4], and were initially adopted by the Chinese government to help create faster capital accumulation and stimulate the development of industrialization and economics by curbing domestic consumption through very low deposit interest. Johansson (2012) gave another explanation on the form of financial repression policies in emerging countries, including China, which put the blame on “developed-country central bank policy based on 'zero-bound' interest rates”. He argues that emerging market economies have no choice but to control capital inflow and excessively lower domestic deposit interest rate because many developed-country central banks, such as European Central Bank, the Bank of England, and the Bank of Japan, have followed the U.S. Federal Reserve’s to put downward pressure on long rates. They these emerging market economies did not do so, they “would lose monetary control as foreign hot money poured in the recipient emerging market government would be forced [to] intervene to prevent its exchange rate from appreciating precipitously” [5].

However, China is not the first country to adopt financial repression policy to motivate domestic economic development. Korea has actually experienced significant periods of financial repression in the 1970s which also played an important role in their overheated housing market. Korea’s economic growth greatly relied on “strong directed credit policies”. They include “favoring the commercial banking system while suppressing private bond and equity markets. Then governments impose high reserve requirements and rely on the obligatory holding of government bonds to tap savings at low-interest rates or zero cost to the public sector”[6]. As a result, opposite to government’s original expectation, instead of mobilizing household savings, the real estate market in Korea had become a substitute for the equity market and the holding of financial assets. The implementation of financial repression policy has generated significant distortions in Korean housing sector, and “the speed of real estate appreciation was a massive 14 percent compounded real rate during the period 1963-1974” since “the behavior of households and their desire to accumulate wealth” is the main point through which financial policies and urban investment could be connected. The housing provides the dominant saving instrument for most families in developed economies, and it is the even more important saving instrument in developing countries [6].

China’s current situation and financial repression policy and the case of Korea in 1970s are quite alike to some extent. To encourage large and state-owned enterprises and finance government itself to support public expenditure, Chinese government also adopt a series of financial and monetary policies. The low real interest rate and strict capital control, combined with suppression of private bond and equity market, all together encouraged domestic households to increase their wealth accumulation by investing in housing market. One main difference of China’s financial market from Korea’s is the great amount of credit availability of banks. For Chinese households, mortgage loans from banks is their main source of financing for house purchasing, which actually further motivates house buying in the market. Therefore, we cannot deny the negative consequences of financial repression policies and the similarity of real estate speculation caused by financial repression, although it has been the engine for the whole economic growth.

This is an excerpt taken from an original work by Anqi Lei, Department of Government and Public Administration, University of Macau, Macau, China. Views and opinions expressed in the adaptation are the sole responsibility of the author or authors of the adaptation and are not endorsed by Anqi Lei.

Cite this Article:

Lei, A. (2017) The Political Economy of Financial Repression Policy-Dominated China’s Overheated Housing Market. Chinese Studies, 6, 213-233. doi: 10.4236/chnstd.2017.64021.


[1] Giovannini, A., & Melo, M. D. (1990). Government Revenue from Financial Repression (Vol. 83, pp. 953-963). The World Bank.

[2] Lardy, N. (2008). Financial Repression in China. Peterson Institute for International Economics Policy Brief, September.

[3]     Borst, N., & Lardy, N. (2015). Maintaining Financial Stability in the People’s Republic of China during Financial Liberalization. Peterson Institute of International Finance. https://doi.org/10.2139/ssrn.2588543

[4] Johansson Anders, C. (2012). Financial Repression and China’s Economic Imbalances. Stockholm School of Economics CERC Working Paper. https://ideas.repec.org/p/hhs/hacerc/2012-022.html

[5] Schnabl, G. (2012). Monetary Policy Reform in a World of Central Banks. https://doi.org/10.2139/ssrn.1998092

[6] Renaud, B. (1988). Compounding Financial Repression with Rigid Urban Regulations: Lessons of the Korean Housing Market. Review of Urban & Regional Development Studies, 1, 3-22. https://doi.org/10.1111/j.1467-940X.1989.tb00001.x
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