Rising Interest Rates Challenge China’s Growth Model
As its economy diverges from the U.S., China faces only hard choices.
Not as easy as it used to be.
Photographer: Qilai Shen/Bloomberg
For years, the Chinese economy has benefited from an unusual dynamic. Because China uses a soft peg to the dollar, its interest rates are tied to the Federal Reserve. Following the financial crisis, as the Fed kept rates exceptionally low for a prolonged period, China was able to set its own rates lower than would otherwise have been necessary, thus underwriting its investment-led growth model.
Now this model is under significant pressure. The People’s Bank of China is trying to keep rates low in an overleveraged economy, while the Fed is raising them to keep a lid on inflation. The tightening yield spread between the two countries will threaten the yuan’s link to the dollar and pressure the PBOC to raise rates. How China handles this decoupling is of critical importance to its economic future.