Financial repression: China versus India

Financial repression is a term used by economists which means the government taking ordinary people’s savings to achieve some goal, typically to pay for the government itself, by exploiting imperfections in the financial system. It is an indirect form of a much more widespread process, that of governments (or the elites which control them) commanding resources in the economy for their own uses. The historically extreme form was forced labour or slavery, in which a king, pharaoh or emperor forced the building of tombs, palaces or temples. Financial repression is less obvious to people, so it can  be used even in a democracy. To some extent it is an alternative to taxation, which is a more obvious and legitimate way for the state to take resources. But because it is less transparent, there is a risk that governments use financial repression excessively.

Governments can take resources with more or less legitimacy from their citizens to use for various purposes. Financial repression is when this happens through stealthy distortions in the financial system, and people are unable to escape. Highly liberalised systems make financial repression very difficult, because savers have alternative places to put their money. Less liberalised systems have the potential for deliberate or incidental extraction of savers’ wealth by the government.

Few financial systems are as liberalised as those of the UK and US, so financial repression in some degree is quite common. Here are two major examples.


China’s form of financial repression in the last decade or so has been to instruct the banks (which are nearly all state owned) to keep deposit and lending rates low and then to lend money at those low rates to state owned enterprises or local government finance vehicles. For most people there is little practical alternative to putting savings in a bank. The institutional savings industry is still in its infancy, most people distrust the stock market because they see it as dominated by insider trading, and there is not much of a bond market, which in any case is also controlled by the government.

So Chinese households, which save a high proportion of their income in the absence of a welfare state (though this is gradually changing), reluctantly put their money into the banks. Their funds are then on-lent at low rates to the state’s chosen borrowers. The extent of repression varies. Inflation has fallen in the last year and deposit rates have inched up so the real loss of income is now quite small. Indeed, the real rate of interest on deposits is lower in the UK and US, where monetary policy has brought deposit rates to very low levels.


India has a different mechanism, the “statutory liquidity ratio” (SLR). Indian banks must hold 23% of their assets in the form of government bonds (it was cut from 24% in July). This is far higher than they would naturally choose to do. It means that the banks must pay lower rates to their depositors than they would be able to do if they could invest in higher return assets and it distorts the financial system’s ability to fund the private sector.

The official reasons for the policy are to restrict the growth of credit to the private sector and to ensure the financial strength of the banks. But both of these goals can be achieved by other means and the real reason is to make it easier to fund the government’s deficit, meaning that interest rates are lower than they would otherwise be. In effect, by cutting the government’s interest payments, this policy reduces the need for taxation. But it is much better to be explicit about a government’s spending and taxation so that the people can clearly see what the state is doing with their money.

SLR is mis-named. Liquidity is the ability to turn assets into cash at short notice at low cost. The Basel II and III rules require banks to hold a proportion of their assets in liquid form, including high quality securities such as (some) government bonds. But 23% is vastly in excess of any plausible liquidity needs.

Rich countries

Financial repression is not only an emerging economy phenomenon. Rich country governments in the past have forced financial institutions to help finance their budget deficits by restricting those institutions’ ability to invest abroad. The high inflation of the mid 1970s made government bonds very poor investments in the US and UK but insurance companies and pension funds were required to buy them, thereby accepting negative real interest rates on behalf of the households whose money they managed. The US put a ceiling on interest rates (“Regulation Q”) right up until the early 1980s, which hit savers hard during periods of high inflation (and stimulated the growth of the money market fund industry, which was exempt from the interest ceiling). This policy originated in the great depression of the 1930s but its effect was to reduce the cost of government borrowing for many years, at the expense of ordinary households. In the UK the abolition of exchange controls in 1979 meant institutions could invest abroad, thus ending the government’s monopoly position as provider of high grade fixed income securities.

A fully liberalised financial system can, as we know, malfunction in various ways, but it is less vulnerable to financial repression because people have choices and can evade attempts by governments to cajole them into lending money at below market rates. Governments in rich countries now mainly have to fund their deficits in a clear way, by borrowing in the open market or by raising taxes. That doesn’t stop the state grabbing resources from the rest of the economy but it makes the process a bit more auditable.

The low rates of interest currently paid in the UK and US do mean that savers are getting a lousy deal, with negative real interest rates. That is a result of a deliberate policy by the central banks to help debtors and stimulate the economy. Since the state is also a debtor this policy does help the government too, but it is not intended mainly or solely to fund the government, so it’s not really financial repression, even if it feels pretty repressive to savers.

Further reading

General analysis of financial repression:

Financial repression in China:

Financial repression in India:

  1. David S.

    The last sentence is key. I had read a lot about Reinhart and Kirkegaard, but I hadn’t actually read them until now. Reading what they wrote, they sound surprisingly alarmist given their academic stature. It seems to me that to talk about financial repression, you need to demonstrate efforts to divert real resources to government debt, aside from taxes. Using non-real resources – printing money, in the absence of inflation, which is what QE does – is not the same. Also, restricting incoming capital is not the same either. The real financial repression countries restrict *outgoing* capital. Finally, the authors look at negative real interest rates to come up with an index of “liquidation effects,” but negative *nominal* interest rates also exist from time to time. These are clearly no caused by central bank official rates, which do not go below zero, so the effects they document are too strong for their own explanation. There’s obviously a demand side to bond rates which they completely ignore.

    It’s a shame they conflate emerging-market problems with developed-country problems, because the problems you mention in India and particularly China are seriously distorting global finance.

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