Some Aspects of Interest Rate Policies in Less Developed Economies: The Experience of Selected Asian Countries

ONE OF THE BASIC PROBLEMS facing most less developed countries is the scarcity of domestic capital in relation to the size of investment required to achieve high and self-sustaining rates of growth of national and per capita real income. Although the accumulation of capital is not the prime determinant of economic growth, its role as a necessary, even if not a sufficient, condition in the economic development of the less developed countries is widely recognized.1 The econometric evidence on the relative contribution of different inputs to growth, although by no means conclusive, bears this out (see Table 1).

Abstract

ONE OF THE BASIC PROBLEMS facing most less developed countries is the scarcity of domestic capital in relation to the size of investment required to achieve high and self-sustaining rates of growth of national and per capita real income. Although the accumulation of capital is not the prime determinant of economic growth, its role as a necessary, even if not a sufficient, condition in the economic development of the less developed countries is widely recognized.1 The econometric evidence on the relative contribution of different inputs to growth, although by no means conclusive, bears this out (see Table 1).

ONE OF THE BASIC PROBLEMS facing most less developed countries is the scarcity of domestic capital in relation to the size of investment required to achieve high and self-sustaining rates of growth of national and per capita real income. Although the accumulation of capital is not the prime determinant of economic growth, its role as a necessary, even if not a sufficient, condition in the economic development of the less developed countries is widely recognized.1 The econometric evidence on the relative contribution of different inputs to growth, although by no means conclusive, bears this out (see Table 1).

Table 1.

Selected Countries: Estimated Contribution of Certain Inputs to Growth of Gross Domestic Product (GDP), 1949–59

(In per cent)

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Source: Odd Aukrust, “Factors of Economic Development: A Review of Recent Research,” Weltwirtschaftliches Archiv, Band 93 (1964–II), p. 39.

The importance of capital accumulation is also reflected in the use of savings as an explicit variable in most economic growth models, a typical example of which is the well-known Harrod-Domar model. In view of the crucial role of capital accumulation, the price of capital as measured by the level and structure of interest rates may justifiably be expected to assume an important role in the economic policies of the less developed countries. But, paradoxically, positive interest rate policies have been conspicuously lacking in the developing economies, apart from a few notable exceptions, such as the Republic of China (hereafter referred to as China), Korea, and, more recently, Indonesia. Even in the literature the emphasis has been more on the structure, behavior, and determinants of interest rates than on the policies pursued.2 Discussions of interest rate policy in the less developed countries have been concerned largely with the role of interest rates as “loan” rates, that is to say, as a means of regulating the cost and availability of credit.3 But interest rate policy has other relevant aspects than the purely monetary. For instance, interest rates can be viewed as instruments for more effective mobilization of savings (as deposit rates) through the offer of realistic rates on monetary savings, such as time and savings deposits, claims on financial institutions, and government securities. Similarly, interest rates can be viewed as a social rate of discount to determine the optimum allocation of savings between consumption and investment and as a rationing device for efficient allocation among alternative forms of investment. Therefore, a purposive interest rate policy has different aspects, each of which is relevant for particular phases of monetary policy or development planning. Consequently, interest rate policies have to reconcile the conflicting requirements of rates that are appropriate to the desired level and composition of investment and also attractive enough to stimulate savings. This calls for policies aimed at an optimum level of interest rates as well as a proper spread between different rates in keeping with the changing requirement of economic growth and stability.

The present paper attempts to analyze the potentialities and limitations of interest rate policies as an integral part of the broad strategies for mobilizing domestic savings in developing countries. It takes into account the experience of China and Korea, which used a high interest rate strategy, and of Malaysia and Singapore, where comparatively low interest rates have been associated with rising levels of monetary savings.

The role of interest rates in helping to mobilize voluntary domestic savings merits much closer attention, not only because of its bearing on the economic growth of the less developed countries but also because of the general skepticism regarding the efficacy of interest rates in mobilizing savings;4 this skepticism in turn derives from the lack of a determinate causal link between rates of interest and aggregate real savings in the national accounts sense, or even between interest rates and financial savings. Moreover, even for personal savings, the econometric evidence, while by no means conclusive, does suggest that such variables as the level, distribution, and rate of growth of disposable income, wealth, price levels, industrialization, and urbanization are far more influential than rates of interest in explaining observed variations in the savings/income ratio.5 In fact, efforts to introduce fiscal and monetary variables, such as taxes and interest rates, into savings functions have not been notably successful. Thus, the inductive evidence appears to justify much of the received doctrine on the relative unimportance of interest as an incentive for saving.6 All this reflects the complexity of the determinants, motives, and incentives underlying the savings behavior of individuals and households, which is, moreover, subject to life cycles. For instance, saving may be for a specific purpose (the Harrodian “hump saving”), for old age, for inheritance, or for unknown future contingencies. It is in fact even debatable how far the act of saving, which is really a residual between income and consumption, partakes of the nature of deliberate and purposive behavior, except for contractual or compulsory savings. Strictly, saving, which is something negative, is not a resource or a quasi-resource and cannot therefore be an overall restraint on growth, although “finance” can act as a constraint on households and firms. The uncritical treatment of saving as a resource and its implicit use as a numeraire for valuing other resources can therefore be misleading.7 But while the concept of saving as a residual is true of aggregate saving in the typical Keynesian model of an economy at less than full employment, it does not necessarily hold good for particular components of saving, still less for saving by particular persons or groups in specific forms, such as interest-bearing assets. It would be unrealistic to deny the existence of an ex ante savings gap that acts as a constraint on the rate of growth. The question then is this: What role can an interest rate policy play in mobilizing saving in financial assets in developing economies and in influencing the general climate for aggregate real savings?

I. Problems in Selecting Criteria for Assessing Interest Rate Policies

Limitations of a priori criteria

Before discussing the potentialities and limitations of interest rate policies, it is pertinent to refer to some conceptual problems involved in the selection of criteria to assess the effectiveness of interest rate policies as well as in the choice and interpretation of interest rate statistics as a basis for policy making.

Since capital is scarce, it follows that there should be an incentive for saving as well as a device for its efficient allocation among alternative uses. These twin functions are discharged, although with varying efficiency, through the interest rate mechanism. But even a perfectly competitive capital market does not ensure an optimum level of savings or a socially desirable pattern of investment. In the less developed countries, where capital markets are subject to even more imperfections than in developed countries, the structure and level of interest rates as determined by the free play of demand and supply do not always reflect the true economic cost of capital. This raises the question of what, if any, the rational and practical criteria are for an interest rate policy in the developing countries.

Although many attempts have been made to derive a conceptual rate of interest, variously defined as the “accounting” or “shadow” rate of interest,8 as a theoretical norm with which to measure the deviation of actual rates of interest, their practical utility is questionable. First, such models are essentially aggregative, static equilibrium models based on highly restrictive and unrealistic assumptions, such as a closed economy, perfect competition, production functions with constant returns to scale, constant savings ratios, constant marginal propensities to save, the absence of state interference, and the lack of technical progress. All these assumptions are scarcely relevant to the problems of developing economies, which have to accumulate capital at an increasing rate to attain self-sustaining growth. The assumption of constant savings ratios is particularly restrictive, as it abstracts from the crucial relationship between the savings function and the levels of income and interest rates and its bearing on the process of growth. Second, such models raise difficult empirical problems of measurement of the relevant variables and parameters, such as the stock of capital, output/capital ratios, factor shares, savings ratios, which are by no means easy to estimate in the less developed countries because of the paucity of basic data. Moreover, they yield a unitary rate of interest9 for the whole economy that, however elegant theoretically, can scarcely function as even an approximate index of the real cost and availability of savings in the highly fragmented capital markets with the multiplicity of customer interest rates that is typical of the less developed countries. It is therefore hardly surprising that even the most sophisticated development plans in Asian countries have not used shadow rates of interest. These criticisms of the operational significance of shadow rates do not, however, detract from the heuristic value of such models. They can serve as broad guidelines for more efficient allocation of resources, particularly if a system of accounting prices were adopted for valuation of all major scarce inputs, such as foreign exchange and skilled labor.

The impracticability of identifying optimum rates of interest also reflects the more fundamental problem of finding objective criteria for “optimum” saving10 or “optimum” investment, because a major issue in the choice of the optimum rate of saving is one of equity between the present and the future, and this cannot be resolved without recourse to temporal value judgments. Obviously, if it is difficult to optimize savings or investment without value judgments, the same objections would apply to optimum rates of interest.11

Some possible empirical criteria

Since there are no operationally meaningful a priori criteria of what constitutes a realistic and appropriate level and structure of interest rates for any economy, policy in this respect is necessarily reduced to a matter of judicious empiricism, keeping in view the objectives that are sought to be achieved through regulation of interest rates. Therefore, interest rates are best regarded as “multivalued instruments” rather than as “targets” of economic policy. The appropriateness of interest rates therefore must be judged strictly in relation to policy objectives, depending on the aspect of interest rates that is to be assigned the greater weight, i.e., their possible role as an incentive to financial savings (income factor) or as an instrument of credit policy (cost factor). Although policy has to be based on a delicate balancing of the multiple role of interest rates, the present paper is concerned largely with their potentialities in mobilizing financial savings in the organized sector.

In this context, a useful but not wholly unambiguous criterion is to examine whether the money rates of interest on typical savings media, such as bank deposits and government securities, are positive in real terms after deflating their nominal levels for changes in the purchasing power of money as measured by some appropriate index. But the significance of the resultant real rate would depend on the indices used, the terms and maturity of the interest-bearing asset, etc. The cost of living index, being more relevant to savings decisions than are variations in the wholesale price index, would be a fairly satisfactory index. But the criterion of ensuring a positive real rate of interest, which is exceptionally significant in periods of high or rapid inflation, ought not to be applied uncritically regardless of prevailing conditions. A substantial volume of financial saving takes place irrespective of whether the real rate of return is positive or negative, because of a variety of factors, such as the money illusion, the minimum demand for cash balances, and the captive market for government securities. Moreover, a rigid adherence to the yardstick of positive real rates of interest may necessitate the manipulation of money rates every time the rate of price change altered and when the upward change was sufficiently large to bring the real rate below zero. Such frequent changes in money rates are neither desirable nor feasible and may even have unsettling effects on the propensity to save in financial media, even if the frequency of change in money rates could be diminished by using a moving average of current and recent rates of inflation. A rational interest rate policy therefore has to be predicated on the basis of fairly stable expectations for reasonable periods of time.

Insofar as expectations of rising, not steady, prices become normal, the effects of even high nominal rates of interest may be dampened. For instance, if prices are confidently expected to rise at 3 per cent per annum, a nominal rate of interest of 6 per cent would be the same in real terms as a rate of 3 per cent. Consequently, given sufficiently inflationary expectations of rising prices, even a relatively high nominal rate of 6 per cent would be regarded as merely normal. The nominal rates will therefore have to be raised sufficiently high if they are to exercise any restraining effect and to ensure consistently positive real rates of return on financial assets. A policy of ensuring positive rates of return through the manipulation of nominal rates has several advantages over “indexing” devices. It obviates difficult technical and administrative problems of linking the nominal value of savings media to some index, such as prices, gold, or foreign exchange, since it operates through the price mechanism. It does not carry any implicit official acknowledgement of the inevitability of inflation and the incapacity of the authorities to control it. The successful experience of China, Korea, and, more recently, Indonesia in ensuring positive real rates of interest through manipulating nominal rates rather than by resorting to indexing techniques testifies to the merits of this approach to a savings strategy, at least in developing economies. The indexing technique, significantly, has been found more practicable in comparatively sophisticated economies, such as Finland and Israel, although it is arguable that even in such economies an interest rate policy could be more efficacious. But, if pursued in isolation, even a positive interest rate policy might be open to the objection, equally applicable to indexing devices, that for any economy to seek to protect the value of one category of income (returns on financial assets) without similar protection to other categories (such as wages or rent) would be inequitable and inefficient. This, however, should be regarded as arguing the need for a coherent and comprehensive incomes policy rather than as a demerit of an interest rate policy.

The broad criterion of assessment of interest rate policies adopted in this paper is their efficacy in mobilizing voluntary private (financial) saving. It will be argued that the level of interest rates can help to influence rates of financial savings in developing countries and probably total real savings in the national accounts sense. Insofar as there is a critical range within which interest rates could be said to be effective in evoking larger financial savings, there is a strong case for a flexible policy aimed at a realistic level of rates high enough to stimulate saving without constricting the rate of development. By maintaining interest rates at unrealistic levels, developing countries may thereby deny themselves the use of a potent instrument of policy. On the other hand, interest rates need not always be high and rising or pegged at a given level. Rather, a minimum objective should be to ensure a positive real rate of return to the saver and, as long as this condition is satisfied, the level and spread of nominal rates can vary in keeping with other requirements of policy. In fact, the choice is not so much between once-for-all high or low interest rate strategies as between rigid and flexible policies. The monetary authorities would therefore need to raise or lower interest rates steadily and progressively over a period of time. It would therefore not be enough to establish a new level of interest rates and then merely seek to maintain it. There might, however, be occasions when a policy of stable nominal rates might be both desirable and feasible. It is, however, difficult to measure and predict the magnitude and speed of response of the volume of saving to interest rate changes, even if it were possible to draw broad inferences regarding the direction of the impact. In less developed economies there is likely to be a considerable dampening of the speed and impact of changes in capital values (interest rates) on savings behavior because of the low ratio of financial assets to gross national product (GNP).12

Likewise, interest rate changes are more likely to affect rates of financial saving and therefore their net impact on aggregate real savings cannot always be known and identified. Even for interest-bearing financial assets, interest rate changes may merely change the form of saving without affecting the total, as, for instance, when savers decide to “switch” from idle cash balances into time deposits or from the latter into government bonds. Since it is more important to increase total net savings, the forms that they assume are relatively subsidiary. Thus, the mere holding of idle balances (currency or demand deposits) is as much an act of saving as the holding of near-money assets and bonds, as both involve the decision not to spend and to release real resources.

On the other hand, the forms that savings assume are of consequence from other points of view. The flow of savings into interest-bearing financial assets in the organized sector facilitates a more efficient allocation of savings between competing uses by subjecting them to the discipline of the price mechanism of the money and capital market; it also enables the monetary authorities to exercise better control over the asset preferences of the financial system and of firms and households, since financial assets are more sensitive to changes in interest rates. Savings held in idle balances are liable to be dishoarded more easily than financial assets. Therefore, there are net advantages in a transfer of savings into interest-bearing financial assets, particularly for the less developed economies. From this point of view, a purposive interest rate policy has to seek to extend the organized sector relative to the unorganized sector by, among other things, maintaining interest rates within a “critical area,” i.e., one within which financial savings and probably total savings are responsive to changes in the structure and level of interest rates. In fact, a good test of policy is to examine whether the interest rate weapon has been fully used within these limits.

Among other possible criteria of the appropriateness of interest rates in the organized sector of the less developed countries are the levels in (1) the unorganized sector in the same country and (2) developed economies. But the rates in the unorganized sector are not meaningful for evaluating rates for organized finance, since the former contain substantial elements of monopoly profit, high-risk premiums, and excessive costs of administration. Moreover, as one of the prime objectives of policy in the less developed countries is to reduce the usurious levels of interest rates in the unorganized sector, it is hardly appropriate to invoke them as a basis for judging levels in the organized sector.

Comparison with rates in developed money and capital markets abroad is perhaps more meaningful if the less developed country in question is an open economy with freedom of movement of short-term and long-term funds. But even in those countries that have assumed the obligations of Article VIII of the Fund’s Articles of Agreement, such as Malaysia and Singapore, there are controls on the transferability of funds on capital account. Short-term rates on treasury bills and commercial paper abroad in competing markets—such as London, where domestic funds have freedom to move—are much more relevant. It is, however, a matter of judgment as to how far rates abroad should influence domestic rates. Moreover, it is arguable that capital movements are also influenced by speculative and confidence factors as well as interest rate differentials.

While the level of rates abroad may not have much direct relevance for domestic interest rate management for economies with almost wholly insulated national money and capital markets, such as India and Ceylon, it may well furnish a useful guideline, inasmuch as rates in capital-scarce countries, prima facie, would need to be higher than comparable rates in developed countries with higher rates of financial saving. This is, however, a complex theme, which is examined critically in the next section of this paper.

Limitations of interest rate statistics

Any discussion of interest rate policies has necessarily to take account of the limitations of existing information on the structure and level of interest rates. In the absence of adequate data on the structure and behavior of interest rates in the unorganized sector, as distinct from rates that merely help to convey some representative “orders of magnitude,” the scope of this paper is limited mainly to interest rates in the organized sector. Even in this sector the published data relate either to minimum or maximum interest rates or to some representative rate. But in order to arrive at the actual effective rates, nominal rates (for lending rates) have to be appropriately adjusted upward for (1) compensatory balance requirements, which often range as high as 20 per cent and (2) commission charges and commitment fees. These items (which vary from bank to bank and sometimes even from customer to customer), in conjunction with the nominal interest rates, have the effect of raising the actual rates to a point that is even higher than the permissible maximum. Moreover, for a more precise evaluation of the significance of quoted interest rates, one would need a weighted average of lending rates, with the weights being assigned according to the volume of lending at each quoted or customer rate of interest. Such data, however, are virtually impossible to collect, and it is consequently difficult to arrive at a “weighted” average of loan rates of interest. Moreover, “not only is there a whole range of interest rates, but also a variety of conditions which may be attached to a loan. Each transaction, therefore, has its unique characteristics. As a result, for each borrowing operation there is one particular rate of interest, which is the Relevant Rate of Interest.” 13 There is therefore in the real world a spectrum of interest rates with credit being rationed at each level.

On the other hand, for deposits the nominal quoted interest rates usually represent the rates actually paid to the customer, except in rare cases, such as call money deposits, where prime customers may get slightly more favorable rates than those published. But, by and large, finely quoted customer rates are more characteristic of loan rates than of deposit rates. Therefore, on the whole, published rates on deposits are a better approximation to actual rates than are loan rates.

But the information on deposit as well as bond rates has to be suitably qualified to take account of such factors as premiums, tax privileges (e.g., exemptions), and other advantages from which depositors and bondholders may benefit. For marketable government securities the extent of official support is an important factor, since such support, whatever its other merits, implies that the resultant rates are not strictly free market rates. To that extent they do not represent “pure” rates of interest. But despite this limitation, market yields on government securities represent the nearest approximation in any economy to a pure rate of interest as measured by the obligation that is basically risk free and most widely held.

II. Interest Rate Levels and Policies in Asia

Instruments and rationale of interest rate policies

An interest rate policy may be defined briefly as any official action designed to influence the level and structure of money rates of interest through statutory means, money market intervention, or moral suasion to attain given ends of credit policy and to help in the mobilization of saving through financial media. Such action may comprise (1) statutory ceilings (e.g., usury laws) and regulation of moneylending and pawn-broking; (2) statutory or voluntary interbank agreements on deposit and loan rates; (3) open market operations and bank rate changes; (4) subsidization or regulation of specific rates (e.g., on small savings, export or housing finance, rural credit). In most Asian countries one finds a combination of these instruments applied with varying degrees of efficacy. Usury laws and their ancillary apparatus of regulations are aimed chiefly at the unorganized sector and are therefore left out of account in the present discussion. The two other categories of policy instruments fall largely within the purview of central bank action designed to influence interest rates in the organized money market by changes in the bank rate or in open market operations and/or by interbank agreements. Because of the undeveloped character of the money and security markets in most of these countries and the limited reliance on central bank credit, both open market operations and bank rate changes have limited usefulness. Consequently, in practice, official regulation mostly takes the form of interbank agreements, either voluntary or statutory. This takes into account the statutory powers of central banks to regulate directly the rates on deposits and loans.

But “it is largely as a result of introducing social considerations that the policymakers face a real dilemma, when it comes to the choice of an appropriate level and structure of interest rates.” 14 In fact, the case for a pragmatic approach to interest rate policy based on modification of the market price mechanism by extramarket criteria is even stronger in the less developed countries, owing to the greater imperfections of the money and capital markets and the stronger element of officially determined priorities in the allocation of capital funds.

In the light of the foregoing considerations, we may first examine the empirical evidence on the structure and level of interest rates in Asia, particularly with a view to finding out whether there is any substance in the oft repeated observation that interest rates in the organized sector of the less developed countries tend to be low and rigid. The subsequent sections review the experience of (1) high interest rate strategies in China and Korea and (2) conventional interest rate policies in Malaysia and Singapore.

Are interest rates low in less developed countries?

Unorganized sector

One of the characteristic features of the less developed countries is the prevalence of high interest rates, ranging typically from 24 per cent per annum to 50 per cent and above in the unorganized sector, where credit is supplied by moneylenders and noninstitutional bankers. But these superficially high nominal rates of interest, which can range up to 300 per cent per annum,15 overstate the real price of loanable funds in the unorganized sector. As has been noted, “nominal interest is kept in these conditions, at fantastic levels. But this is mainly a device to keep the peasants permanently in debt. The actual payments exacted cannot exceed the margin between subsistence and rent.”16 The interest on debt cannot physically exceed the surplus between subsistence and all other outgoes (e.g., tax) and not merely rent. Of course, the fact remains that debtors do owe the high nominal interest charges even if they cannot afford to pay them out of current income. The figures of rural rates based on detailed field investigations, such as those of the All-India Rural Credit Survey, show the normal upper limit of rates to be about 50 per cent. Tun Wai’s estimates placed the world-wide weighted average of interest rates in the unorganized sector of the less developed countries within a range of 24–36 per cent.17 Assuming that effective rates in the unorganized sector are within a range of about 24–50 per cent, those would still be regarded as high in absolute terms as well as relatively to those in the organized sector (typically about 10–12 per cent) of the less developed economies and in the developed economies as a whole. On the other hand, the comparable rates for consumption loans in the developed economies are also recognized to be nearly as high as the lower level of rates for noninstitutional credit in the less developed countries.18

Although there are no adequate data, it is reasonable to assume that it is the unorganized sector, with its high interest rates, that finances the bulk of total credit requirements in most of the Asian countries, whereas the organized sector, with its comparatively low rates, finances about one fourth of the aggregate credit. Indian experience in this matter, which may be assumed to be not untypical of Asia as a whole, is revealing. The Indian Central Banking Enquiry Commission in the 1930s estimated the share of unorganized banking at about 90 per cent. The All-India Rural Credit Surveys in the 1950s and 1960s showed that this ratio had not changed significantly despite the impressive growth of institutional banking facilities; organized banking still accounts for only about 15 per cent of total credit in rural areas.19

These facts pose a paradox: what is the role of interest rate policy in countries where nominal rates of interest for the most part are high enough to reward the effort of saving and where the problem therefore is really to reduce the cost of credit. In fact, the existence of usury laws in many developing countries points to the need to reduce the high average rates of interest on loans by eliminating the high-risk premiums and monopolistic profits in the moneylending business. But the paradox presented by these facts is more apparent than real. For one thing, the high rates of interest in rural areas are exclusively lenders’ rates that are applicable only to loan transactions and not to deposit transactions. Moneylenders do not usually accept deposits, and in the event of acceptance the rates are far below those for loans. This highlights one of the distinguishing features of noninstitutional banking in developing countries, namely, the virtual absence of any link between deposit rates and loan rates. The latter are therefore in the nature of autonomous rates. The customers of noninstitutional lenders are almost exclusively borrowers (agriculturists and artisans) whose incomes are too low and fluctuating to enable them to save and hold their savings in financial forms for any length of time. The high rates of interest charged by lenders consequently have little influence on the propensity of the rural sector to save. Therefore, from this point of view an appropriate interest rate policy for the unorganized sector should aim at reducing rates to more economic levels through multiplication and diversification of competitive sources of credit and a broad-based program of improved production and marketing in order to enhance the creditworthiness of the rural borrower.20

The organized sector (a critique of the Myrdal thesis of low rates)

In the less developed countries the level of interest rates in the organized sector (comprising joint-stock banks, other financial institutions, security markets, etc.) tends to be substantially below that in the unorganized sector. They are almost the same as, or lower than, similar rates in the developed countries, where savings are much higher; and even where the rates are slightly higher than in the developed countries, it could be argued that the gap does not fully reflect the relative scarcity of capital that is normally characteristic of such economies. To that extent, the rates are adjudged to be low and therefore unrealistic and inappropriate. Often such judgments tend to partake of obiter dicta not substantiated by any detailed analysis or empirical investigation.21 A conspicuous exception is Myrdal’s analysis 22 of the inappropriateness of low interest rates in the organized sector, which, being among the most substantial of its kind, merits critical appraisal as representative of this point of view even though it was made in the context of the insulated credit and capital markets of India, Pakistan, and Ceylon. Its main propositions may be summarized as follows:

Despite the great scarcity of capital in the less developed countries in comparison with the developed countries, it is paradoxical that rates of interest, despite recent increases, are conspicuously low and in fact not as high as in many developed countries. This paradoxical policy has been sustained by a combination of selective and discretionary controls on credit and investment and by concessional finance, and is sought to be justified on the grounds of inappropriateness of high interest rates in developing countries and the insensitivity of investment to interest rate changes in a highly protected economy.23

On balance, according to Myrdal, a substantially higher level of interest rates in conjunction with a dismantling of discretionary controls would be more in harmony with the prevailing scarcity of capital in the South Asian countries and would induce economy in the use of capital. It would stimulate greater inflow of foreign capital and mobilize more domestic saving in productive forms instead of being dissipated in speculation, hoarding (particularly of gold), conspicuous consumption and investment, and purchase of land (at inflated prices) and foreign securities. It would also bring about a decline in oligopolistic profits and in capital and land values; the latter would enhance the feasibility and reduce the cost of large-scale changes in land ownership and tenancy. Since the major portion of government debt is intragovernment debt, higher interest rates would only bring about a change in accounting relationship within the public sector. Insofar as bonds are held by private persons, higher rates would tend to bolster the rentier class but higher incomes from this source would be easy to trace and to tax, even if income from loans in other forms would, as now, be more difficult to trace.

We may now examine critically the validity of the Myrdal thesis in the context of Asian economies and its policy implications.

A comparison of the relative range of interest rates (Table 2) in the developed and less developed countries suggests that Asian countries are in two clearly defined groups, namely, Group I (Burma, Ceylon, India, Malaysia, Nepal, the Philippines, Singapore, and Thailand), which has more or less conventional rates of interest that are about the same as or lower than those in the developed countries, and Group II (China, Indonesia, and Korea), with interest rates that are far above those in the developed countries or other less developed countries. In fact, the nominal rates in the organized sector in these three countries approximate those in the unorganized sector of the countries that have low interest rates.

Table 2.

Developed and Less Developed Countries: Comparative Rates of Interest, 1958–69

(Range in per cent per annum) 1

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Sources: International Monetary Fund, International Financial Statistics; national sources.

Approximate range between low and high figures.

1969.

One year.

Postal.

Overdrafts.

Post Office and Trustee.

Seven days’ notice.

Prime rate.

Three months.

Certificates.

October 1969.

1949-69.

Rediscounts.

Since October 1968.

1968.

Private banks.

1961–69.

In terms of comparative nominal interest rates, Myrdal’s generalization would therefore appear to be valid only for some countries in Group I. Even within this group it would be misleading to generalize about countries in which financial saving shows varying degrees of response to more or less similar levels of interest rates. For instance, even with comparatively low and stable nominal rates of interest the growth of financial saving in Malaysia and Singapore, as shown in a subsequent section, has been impressive partly because the real interest rate has been positive, owing to prolonged price stability and the resultant confidence of the investor in financial assets. It would therefore be interesting to compare the real interest rates between the developed countries and the less developed countries that have low interest rates. To illustrate this, the prevailing nominal rate on postal savings in India, the United Kingdom, and Japan and the savings deposit rate in France and Malaysia is deflated by the annual percentage change in consumer prices in the respective countries, using data from the Fund publication, International Financial Statistics (December 1963 = 100 for all the countries except Malaysia, in which 1959 = 100). The resultant figures (Table 3) show that the real rate on savings deposits was negative in the developed countries in all the years and in India during 1965–67, whereas in Malaysia it was positive in all years except 1967. Although it is difficult to draw any clear-cut inferences from these data,24 they do suggest that the gap between the real rates in the developed and less developed countries is perhaps not perceptibly greater than that in the nominal rates.

Table 3.

Selected Countries: Estimated Real Rate of Interest on Savings Deposits, 1965–69

(In per cent per annum)

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Sources: Estimated from Table 2, national sources, and price indices given in International Monetary Fund, International Financial Statistics.

There is also an interesting parallelism between the similarity of interest rates in the organized sector of the less developed countries and the developed countries, on the one hand, and the relative average capital/output ratios (Table 4) and the average rate of return on capital in manufacturing (Table 5), on the other hand. This suggests that as the organized sectors in the less developed economies are developed enclaves they have more in common with the developed economies than with the unorganized sector in their own countries. Borrowing by the organized sector in the less developed countries is likewise from the same sector and hence it is feasible at the lower rates prevailing in that sector. Neither the governments nor the financial institutions borrow directly from the unorganized sector where interest rates are higher. Thus, the dualism of the financial sector and the coexistence of non-competing capital markets conceal the fact that the borrowing is from the low interest rate sector, which does not necessarily reflect the overall scarcity of capital in the economy.

Table 4.

Selected Countries: Average Capital/Output Ratios, c. 1960

(In per cent per annum)

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Source: Raymond W. Goldsmith, Financial Structure and Development (Yale University Press, 1969), Table 6-3, p. 294.
Table 5.

Selected Countries: Average Rate of Return on Capital in Manufacturing,1948–58

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Source: Bagicha Singh Minhas, An International Comparison of Factor Costs and Factor Use (Amsterdam, 1963), Table XVI, p. 88.

Percentage rate of return before corporate taxes.

Based on census data.

Based on data from the Reserve Bank of India.

The feasibility of government borrowing at low interest rates in the less developed countries reflects, first, the existence of a captive or guaranteed minimum market for government loans arising from the statutory requirements stipulating minimum ratios of investments by financial institutions and social security funds in government securities.25 Such requirements coupled with the paucity of equally safe alternative investment outlets make the market for government securities less competitive in the less developed countries. Consequently, it is arguable that institutional and other investors would hold a substantial portion of their portfolios in government securities even in the absence of statutory regulations. For instance, Indian experience shows that, even before the imposition of statutory investment ratios, banks and insurers held government securities at or even above the same level that came to be required by statute. It is also not uncommon for financial intermediaries to hold “excess” (i.e., above the statutory minimum) portfolios of gilt-edged stock. Second, the low rates on government loans are possible because of the strong semimonopsonistic position of governments as borrowers in the less developed countries, which stems from the sheer size of their borrowing operations, and the imperfections of the capital market. Last, the fact that government obligations in all economies, developed or less developed, are virtually risk free makes their yield correspondingly low and uniform by eliminating the risk premium altogether.

Thus, the capacity of the less developed countries to maintain artificially low interest rates below the real cost of capital controverts the belief that the “floor interest rate” is higher than in developed countries.26 This in turn is buttressed by the conventional wisdom that favors comparatively low and stable average interest rates in some of the less developed countries, reflecting the cumulative effect of various factors—intellectual, historical, and institutional. Although it is difficult to indicate their relative importance or historical sequence, it is possible to identify some of the more important influences.

A major obstacle to the adoption of bolder interest rate policies is the notion that a historical level of interest rates—say, in the range of 3-5 per cent—is in some sense a “normal” level.27 The notion of a normal rate, however, stems from historical experience in the United Kingdom and elsewhere as well as being a survival from the era of war finance when it was both necessary and desirable to finance the war effort on the basis of a given and stable basic rate, such as 3 per cent. This experience appears to have strongly colored the thinking in some Asian countries, where one of the implicit assumptions of policy seems to be the desirability of financing long-term development programs on the basis of low and stable rates. But the notion that a low stable rate is normal becomes increasingly inappropriate in a developing economy, where relative prices, including the interest rate, must necessarily reflect relative scarcities of factors and goods.

The historical experience28 of interest rates in the organized sector in the less developed countries has been one of variations within a comparatively narrow range of about 3–6 per cent, which has probably conditioned the authorities to low interest rates. It may be that within this range interest rates have had comparatively negligible effects. But really large changes in the rate of interest—say, 10–20 per cent—might well have a significant effect on decisions about savings and investments. Also, the fact that prevailing levels of interest in the unorganized sector are unconscionably high (20–50 per cent) creates a bias in favor of low and stable interest rates. There is an element of paradox in this attitude insofar as the acceptance of low rates in the organized sector goes together with tolerance of abnormally high rates in the unorganized sector. Logically the case is, if anything, for higher rates in the organized sector and much lower ones than those prevailing in the unorganized rural sector.

To sum up, while one may accept the general validity of the Myrdal thesis in the context of low interest rate countries in Asia, it must be subject to appropriate qualifications.

First, the choice is not between low and high rates but between rigid and flexible policies, somewhat along the lines of the Radcliffe Committee’s “three-gears” approach, with rate changes corresponding to low, medium, and high levels. The rate changes can then take the form of fractional variations (fine tuning) or else of larger steps of 1 per cent or more. But in times of high or rapid inflation the three-gears approach may be rendered inoperative, and the situation may warrant dramatic “quantum” jumps in nominal rates to offset the declines in real interest rates.

Second, even with very high rates it would not be possible to dispense wholly with discretionary credit controls because of the imperfections of the credit market, which give rise to qualitative credit rationing as well as the need to take account of social priorities. But higher interest rates would certainly help to reduce the reliance on discretionary controls and would thereby eliminate the major portion of the massive “disequilibrium” systems found necessary to maintain the existing low rates.

Third, the effects of higher interest rates on the choice of techniques and the degree of capital intensity may be blunted insofar as purely technological considerations determine the minimum size of plant and equipment in industry and construction. A more salutary effect, however, may be a more rational allocation of capital between the public and private sectors, provided that the public sector borrows its requirements in a competitive market.

Fourth, higher interest rates by themselves may not be sufficiently strong inducements either to drastically alter existing asset preferences, e.g., for land and gold, in less developed countries 29 without a radical change in savings psychology or else to attract foreign loan capital. Moreover, the foreign exchange gap can be more appropriately bridged by an inflow of aid and equity capital than by loan capital.

Finally, higher interest rates would help to extend the organized sector of finance and to promote financial intermediation and the integration of the money and capital market. The maintenance of nominal interest rates in the organized sector below their true economic level results in a steady attrition of organized finance. Since only the rates in the organized sector are controlled, the rise in real rates of interest will be confined to the unorganized sectors, resulting in a steady diversion of savings to that sector in search of higher rates of return. This may result in an increase of either consumption or direct investment in the unorganized sector, since lenders in this sector are more prone to make consumption loans. Thus, attrition of organized finance is accompanied by a rise in consumption, a fall in investment and savings, misallocation of savings to investment, and inefficient use of real resources.

Another consequence of this process is the possible adverse impact on the monetization of the economy, at least in conditions of rising prices. Inflation functions as a kind of tax on cash balances and leads to a steady decline in the holdings of money and also in financial assets. On the other hand, the pace of monetization could not be said to depend on the level of interest rates.30

III. The Scope for Interest Rate Policies

The savings pattern in Asia

The potentialities of an active interest rate policy depend on the extent to which the voluntary financial savings of the household sector are responsive to variations in the level and structure of interest rates. The available data on the savings pattern of some selected Asian countries emphasize, first, the sizable share of the household sector in gross savings (Table 6); second, the relatively small proportion of financial assets—between 35 and 45 per cent—except for Japan, 82 per cent, and Ceylon, nearly 66 per cent (Table 7); and, finally, the overwhelming predominance—more than 70 per cent—of the voluntary component in household savings and the correspondingly negligible role of compulsory and contractual savings (Table 8). Together these factors suggest a favorable environment for the use of interest rates to stimulate voluntary financial saving by households. In particular, the still negligible role of contractual and compulsory savings, unlike the situation in the developed countries, indicates a much wider potential scope for interest-sensitive savings by households.

Table 6.

Selected Asian Countries: Sectoral Distribution of Gross Savings, 1954–59

(In per cent)

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Source: United Nations, Economic Commission for Asia and the Far East, Economic Bulletin for Asia and the Far East, December 1962, p. 4.

Derived as a residual by deducting identifiable savings in other sectors.

Net savings.

Table 7.

Selected Asian Countries: Main Forms of Gross Household Savings, 1955–59

(In per cent)

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Source: United Nations, Economic Commission for Asia and the Far East, Economic Bulletin for Asia and the Far East, December 1962, p. 6.

Net savings basis, i.e., net of capital consumption allowances.

Total assets.

Table 8.

Selected Asian Countries: Compulsory, Contractual, and Voluntary Savings of Households, on Net Savings Basis, 1955–59

(In per cent)

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Source: United Nations, Economic Commission for Asia and the Far East, Economic Bulletin for Asia and the Far East, December 1962, p. 10.

1955–59.

1955–58.

1958–59.

This leads to the more difficult question of interest elasticity of personal savings in Asia, on which the available evidence is inconclusive and sometimes conflicting. According to a recent comparative evaluation by J. G. Williamson of some of the major determinants of personal savings in Asia,31 combining both temporal analysis of individual Asian nations and intertemporal cross-section analysis of a large group of Asian countries, “higher interest rates are associated, if anything, with lower real saving in Asia. The explanation would appear to lie in the fact that the savings and investment decisions are highly interdependent in the Asian household sector …. interest rates appear to influence the short-run savings decision far more powerfully than the long-run savings decision.” 32 One of the findings of the study was that for Asia the net impact of real interest rate movements on personal saving was either negative or insignificant (see Table 9).

Table 9.

Selected Asian Countries: Real Interest Rates and Personal Savings1, 2

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Source: Jeffrey G. Williamson, “Personal Saving in Developing Nations: An Intertemporal Cross-Section from Asia,” The Economic Record, June 1968, Table VI, p. 208.

Real interest rates (ri, t) as deflated by cost of living index; personal savings as dependent variable (Si, t); normal disposable income (Y^i,td);and transitory income (Y*i,td).

* indicates lack of significance at 90 per cent level; standard errors are shown in parentheses.

However, another regression analysis, by K. L. Gupta,33 using the same variables as Williamson’s but a different and more reliable set of primary data on savings for India (estimates by the Reserve Bank of India instead of the National Council of Applied Economic Research) arrived at results just the opposite of Williamson’s. Gupta’s results (Table 10) show that while the real rate of interest is not significant at the aggregate level it is more influential in determining personal savings at the per capita level. Apart from the use of more reliable primary data, Gupta’s analysis, unlike Williamson’s, which relies on a single rate of interest as the index of return on financial assets, considers the following real rates of interest as alternatives.

Table 10.

India: Interest Rates and Personal Savings1

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Source: K.L. Gupta, “Personal Saving in Developing Nations: Further Evidence,” The Economic Record, Vol. 46 (1970), p. 248.

Standard errors are shown in parentheses.

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The results of Gupta’s analysis (Table 10) for India show that in all the equations the coefficient has a positive sign, suggesting that higher real interest rates lead to higher real savings.

Although the econometric evidence on the interest sensitivity of personal savings in Asia is thus inconclusive and conflicting, it points to the potentially greater role for interest rates in a country like India.34 To that extent, it provides a promising statistical foundation for the Myrdal thesis. But more than such econometric investigations, with all their inherent limitations, a review of the experience of such countries as China and Korea might yield more meaningful inferences regarding the scope and limitations of an active interest rate policy for developing economies.

Experience of high interest rate strategies in Asia

China

Chinese experience since 1949 is of exceptional significance in highlighting the potentialities of a conscious and purposive interest rate policy in an economy subject to the strains of civil war and postwar inflation as well as developmental expenditures. China is rightly regarded as a pioneer and leading exponent of a high but flexible interest rate strategy.

The monetary history of China since 1949 affords a classic example of conditions in which interest rates become one of the major anti-inflationary instruments. The extent of the inflation that had to be combated and its repercussions on the level of interest rates are brought out in Table 11.

Table 11.

China: Prices and Interest Rates, 1940–46

(In per cent per annum)

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Source: United Nations, Department of Economic Affairs, Inflationary and Deflationary Tendencies, 1946–1948 (Sales No.: 1949.II.A.1), p. 48.

But inflationary pressures and rising prices showed no signs of abatement even after the consolidation of the regime in China after 1945 and, if anything, were aggravated by the growing volume of military expenditure and the influx of refugees from the mainland. In this situation, apart from the political difficulties of higher taxation and compulsory borrowing, there was not much hope of evoking any public response to government bonds or of increased accruals to savings bank accounts despite an annual average rate of increase of 85 per cent in wholesale prices.35 Under these conditions, the Chinese authorities were inevitably led to rely on economic incentives rather than the purely patriotic impulses of the populace. In the monetary sphere this pointed to the use of sufficiently attractive interest rates to induce the public to save more.

But considering the prevailing rate of price rise and the fact that interest rates were already high, evidenced among other things by the payment of interest even on current account deposits (3.24 per cent per annum in 1949), it was evident that the authorities would really need to pitch the rate on new savings instruments at extraordinarily high levels. The Chinese authorities boldly broke through the psychological barrier, which so often inhibits the raising of nominal interest rates above conventional levels, by introducing in March 1950 a special system of preferential deposits of one-month, two-month, and three-month maturities carrying a rate of 7 per cent a month (i.e., 125 per cent per annum compounded monthly). The choice of very short maturities was significant, inasmuch as with the high liquidity preference prevailing under conditions of hyperinflation, it was unrealistic to expect the public to buy bonds of long-term or even medium-term maturities. Thus, initially, the policy comprised a combination of very high interest rates on very short-term maturities. But there was no irrevocable commitment to a policy of rising rates, since this would have undermined the market by inducing investors to hold back in anticipation of further rises. Encouraged both by the response to the new deposits as well as by the decline in the wholesale price index between May and July 1950, the authorities reduced the rate of interest on one-month deposits in July 1950 by one half, to 3½ per cent a month. This reduction led to a slight fall in time deposits, but even so this reaction of depositors proved to the authorities that they had been able to arrive at the “critical area” in which monetary savings had become responsive to interest rate changes. Nevertheless, the authorities reduced the rate to 3.0 per cent a month on one-month deposits. The cut coupled with the resumption of a sharp rise in prices may have led to the fall in the preferential interest rate deposits to a very modest level of NT$21 million in January 1951.

The authorities were concerned, however, to ensure that the rise in the deposit rates was not communicated to loan rates, since this would have affected the working capital requirements of trade and industry. Accordingly, the strategy was adapted to ensure a ceiling on loan rates as well as a “floor” for deposit rates. But the progressive raising of rates on deposits without a corresponding increase in loan rates created an “inverted” interest rate structure with a negative differential between the preferential deposit and loan rates, since the former were raised to higher levels than the latter. To meet this situation a “redeposit facility” was created whereby banks were given the option of placing excess deposits (i.e., those for which they had no immediate outlet by way of investment or loans) in the Bank of Taiwan 36 at rates equal to or above those paid by the commercial banks. This, in effect, protected the commercial banks against losses on the preferential deposits. This facility has proved quite popular with the banks, especially since 1951, as evidenced by the rise of redeposits from NT$6 million in March 1951 to NT$329 million in August 1952. The spectacular rise in redeposits reflected the weak demand for credit relative to the growth of bank deposits in response to the high interest rates. The loss suffered by the Bank of Taiwan in paying higher interest on redeposits than its earnings from loans and investments was substantially offset by the earnings from U. S. counterpart funds deposited with it. But, more importantly, the net cost of “redeposits” to the Bank of Taiwan in financial terms was more than offset by its efficacy in combating inflation, an apt example of external economies of the high interest rate policy.

Thereafter the rate was again increased to 4.2 per cent a month (64 per cent per annum) and was held steady at that level for the next year. By April 1953 the volume of preferential deposits had risen to NT$350 million. At this stage the authorities, reacting to the restoration of public confidence, attempted to stretch the maturity of deposits while keeping interest rates constant through the introduction of six-month deposit certificates at 4.2 per cent a month and one-year deposit certificates at a rate of 3.0 per cent a month. During the second phase of this policy the authorities, encouraged by the continued rise of deposits, reduced rates from 2 per cent to 1.2 per cent (on one-month deposits), 2.15 per cent to 1.3 per cent (three-month deposits), 2.3 per cent to 1.5 per cent (six-month deposits), and 3 per cent to 2 per cent (one-year deposits). The result was a switch to longer maturities, and by the end of 1953 the six-month and one-year deposits accounted for almost half the total deposits.

But despite the subsequent growth of preferential time deposits, there were apprehensions about the excessive potential liquidity and its possible activation through the use of these deposits as collateral for bank credit, a possibility that exposed a gap in the anti-inflationary policy. Consequently, rate adjustments in March 1956 were designed to render shorter maturities less attractive by cuts of 15 per cent and 9 per cent on one-month and three-month deposits, respectively. These reductions were coupled with the offer of premiums of 15.4 per cent and 12.5 per cent on six-month and one-year deposits, respectively, if the depositor chose to forgo borrowing privileges against these deposits. But even this did not remove the inflationary potential of increased liquidity, and therefore all time deposits were declared ineligible as bank collateral. A substantial switch to longer maturities followed, and by the end of 1956 a little more than one fourth of the time deposits were for one year. But the fact that 1956 was also the first year in which preferential time deposits failed to register an annual increase implied that for a large number of depositors the increased premium did not sufficiently compensate for the reduced liquidity. This demonstrated that depositors were as conscious of liquidity as of yield. However, a significant development in 1957 was the abolition of interest on checking accounts with banks (paid at the rate of 3.24 per cent in 1949, 1.62 per cent in 1950-55, and 0.90 per cent in 1956), which betokened the restoration of financial normalcy in the economy.

In the second half of 1957 two-year preferential deposits were introduced, carrying a rate of 1.8 per cent a month, the rate previously paid on one-year deposits. Concurrently, the rate on one-year deposits was reduced to 1.35 per cent monthly and the one-month deposits were discontinued. The three-month deposits (0.85 per cent a month) lost their popular appeal. The volume of one-year deposits more than doubled in 1958; the six-month deposits too approximately doubled between mid-1957 and the end of 1958. By the end of 1958 preferential deposits amounted to NT$ 1,508 million (29 per cent of net money supply), of which almost half was in one-year deposits (1.65 per cent a month) and one third in six-month deposits (1.35 per cent a month). The remainder was accounted for by three-month deposits (0.85 per cent) and two-year deposits (1.8 per cent). At the end of 1958 all preferential interest rate time deposits were terminated in favor of regular time deposits.

In 1959 the high interest rate strategy was extended to government borrowing with the issue of bonds with maturities of 12 to 30 months at rates varying from 9 per cent to 18 per cent. The interest on the 18 per cent bonds, which were sold exclusively to nonbank investors, was paid quarterly and was also exempt from income tax. At the same time the authorities encouraged commercial firms to raise capital through bonds carrying attractive rates of return. During 1958-59 approximately three fourths of private two-year bond issues at 20 per cent per annum were guaranteed by the Government. The nonguaranteed two-year bonds carried an annual rate of 26.4 per cent. At that time secured and unsecured bank loans were being made at 19.8 per cent and 22.3 per cent per annum, respectively, while private moneylenders charged from 36 per cent to 40 per cent.

The years 1958-59, in retrospect, marked the completion of the phase of stabilization that created an environment wherein interest rates could be viewed as a normal instrument of policy. Since that time the authorities have steadily endeavored to reduce nominal rates on deposits and loans in keeping with the improvement in the overall economic situation, the increase in quasi-money, and the relative stability of the cost of living (Tables 12 and 13).

Table 12.

China: Interest Rates on Deposits; Quasi-Money; and Private Savings, 1949–69

(Rates in per cent per annum; 1 amounts in billions of new Taiwan dollars)

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Sources: Central Bank of China, Taiwan Financial Statistics Monthly; Directorate-General of Budgets, Accounts, and Statistics, National Income of the Republic of China.

Rates for savings deposits, discounts, call loans, and time loans are monthly rates at the end of December converted to annual rates. Real rates are adjusted for changes in wholesale prices (A) and consumer prices (B); the rates for 1968 are adjusted for price changes between December 1967 and October 1968.

Rates for 1949-56 are applicable only to banks other than the Bank of Taiwan. The rate on Bank of Taiwan demand (checking) deposits was 0.90 from June 1950 to June 1957, when interest was abolished for the Bank of Taiwan. Interest was abolished for all other banks in the following month. The rate on Bank of Taiwan demand (passbook) deposits was 3.6 per cent per annum from June 1950 to July 1957; from that date until 1961 the rate was 2.88 per cent per annum, the same as paid by other banks.

Rate was applicable only to banks other than the Bank of Taiwan until January 1959, when the latter started to accept three-month deposits at the same rate, 9.0 per cent per annum.

From 1953 to 1958 this rate, applicable to all banks, refers to one-year preferential deposits, which from April 1953 could be pledged as collateral on mortgage loans; after that date the privilege was withdrawn. From 1959, the rate refers to one-year savings deposits, which were introduced in January of that year. Since then no new preferential deposits have been accepted. From July 1, 1963 the same rate has been applied to two-year and three-year deposits.

From International Monetary Fund, International Financial Statistics.

Table 13.

China: Loan Rates of Interest, 1949–69

(In per cent per annum) 1

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Source: Central Bank of China, Taiwan Financial Statistics Monthly.

Rates for rediscounts, call loans, and time loans are monthly rates at the end of December converted to annual rate. Free market rate is monthly average rate (based on quotation in Taipei City for the fifth, fifteenth, and twenty-fifth of each month) for unsecured loans converted to annual rate.

Bank of Taiwan rate through 1960; central bank rate thereafter. The Bank of Taiwan extended credit through call loans prior to the reactivation of the Central Bank. The call loan rate of the Central Bank also applies to its secured advances to other banks.

Beginning on December 8, 1956, differential rates have been charged by the Bank of Taiwan; these figures give the minimum and maximum rates.

Rate for secured time loans through 1955 and thereafter for secured loans of less than one year.

On the whole, the experience of an active interest rate policy in China has pertinent lessons for other developing countries, even those that may not have encountered rapid inflation or hyperinflation. First, it shows that there is a critical zone even in a hyperinflation37 within which an appropriate level and structure of nominal interest rates will not only counter the flight from money into goods but also stimulate financial savings. The rationale of the interest rate policy with its primary accent on deposit rates rather than on loan rates derived from the paramount need in a hyperinflation to increase savings by diverting funds from consumption rather than by merely restraining investment. Second, it also emphasizes that an anti-inflationary policy cannot rely merely on the differential between deposit and loan rates unless it also ensures a positive real rate of return to depositors. Consequently, the nominal interest rates were pitched high enough—in fact far above levels that are regarded as conventionally normal—to yield a reasonably attractive real return to the saver. For the greater part of the period 1952-58 the real rates of interest on deposits were positive but well within the conventional range of rates, despite the high nominal rates. Likewise, over the years the gap between the nominal and real rates of interest has been progressively narrowed, attesting to the feasibility of a policy of fixing nominal rates in increasingly closer approximation to the real rates. Third, it highlights the scope of central bank support of an “inverted” interest rate structure consequent upon a high interest rate strategy.

Another feature is the flexibility of interest rate policies in China as evidenced by the subsequent lowering of lending and deposit rates that was associated with a corresponding rise in the ratio of liquid assets, including quasi-money, to GNP. Thus, the ratio increased from 9.6 per cent in 1953 to 37.4 per cent in 1969, whereas the rate of interest on one-year savings deposits declined from 24 per cent to nearly 10 per cent. This suggests that the disincentive effects of falling interest rates were more than offset by the stimulus to the general propensity to save by the rising levels of income and the progressive strengthening of confidence in the currency. Thus, the overall strategy had two broad phases. In the first phase nominal rates were pitched sufficiently high, or at rising levels, to stimulate financial savings. The levels at which financial savings became responsive to interest rate increases may be described as the first stage of “criticality.” This is the point at which the inflationary psychosis may be said to have been effectively countered. But it was obviously not necessary to maintain rates at this level because, once deposits became responsive, the momentum imparted by the initial rise in rates could be depended upon to sustain future increases in deposits, provided that other factors were favorable. The second stage was reached when the impact of falling, or low, rates was more than offset by rising incomes and confidence, so that despite the lowering of rates there was a progressive rise in financial savings.

Although there are no adequate data covering the whole period, there is reason to believe that the share of unorganized finance in China has gradually declined as a result of the policy of realistic rates in the organized sector. A sample survey of the flow of funds 38 of private enterprise in 1968 showed that the share of the unorganized sector (excluding nonfinancial institutions) in the money and capital market had declined from nearly 45 per cent in 1964 to about 38 per cent in 1967. The impact of the high interest rate strategy on the unorganized sector is also indicated by the progressive decline in the average free market rate for unsecured loans over the period 1949–69 from about 208 per cent to 28 per cent.

It is more difficult to evaluate the efficacy of high interest rates in stimulating total private savings in China, even though the ratio of private savings to GNP has improved over the period as a whole from about 3 per cent in 1953 to a range of 10–13 per cent in recent years. There is, however, no consistent trend in the aggregate private savings in relation to GNP. This, of course, follows from the absence of a determinate causal link between interest rate changes in financial media and the aggregate real savings of the private sector. It would not be straining the evidence too much to suggest that a realistic interest rate structure possibly helped to create a more favorable climate for savings in general, i.e., the spillover effects of the markets for financial media were possibly beneficial in terms of stimulating saving as a whole. This relationship is, of course, admittedly difficult to quantify.

Undoubtedly, the success of interest rate policies in China in mobilizing voluntary private saving was helped by the general economic situation, notably, by the availability and effective use of foreign (U. S.) economic assistance39 and the gradual elimination of the foreign exchange gap by the growth of exports. Even so, the recourse to realistic interest rates must be rated as one of the most influential factors in the economic recovery and growth of China. After all “foreign aid, sizeable as it was, would not have produced stability if it had not been accompanied by the self-help measures adopted by the Chinese. Experience shows that countries which pursue reckless fiscal and monetary policies can consume large amounts of foreign aid and still not achieve the degree of stability attained in Taiwan. Among the factors responsible for the success of the economic program on Taiwan was the use of realistic interest rates to encourage voluntary saving, especially in the difficult early years.” 40

On the whole, Chinese experience aptly exemplifies the role of high but flexible and realistic interest rate policies as a necessary, even if not a sufficient, condition of effective economic stabilization programs. The risk of a large mass of near-money assets impounded by high rates of interest becoming a pocket of latent inflation has been successfully averted by a combination of price and economic stability as well as rising rates of growth.

Korea

The successful experience of China in the use of interest rates as an anti-inflationary weapon also stimulated the interest of the Korean authorities in the possible adoption of similar measures as part of a wider stabilization program for the Korean economy, which had experienced persistent inflation following the political division of the country in 1945 and the economic dislocation in the wake of the Korean conflict. The Korean authorities sent expert teams to China to study41 the techniques used by the Chinese authorities and their results and to suggest possible measures in the light of their investigations. Thus, long before the implementation of the interest rate reforms in September 1965 there was official recognition in Korea of the desirability of a bold and purposive interest rate policy.42 The phase of hyperinflation lasted until about 1951-53. But even thereafter attempts to check inflation met with only limited results despite substantial foreign aid, chiefly from the United States, which financed nearly 6 per cent of total imports in the decade 1953-63. Likewise, counterpart funds generated by foreign aid accounted for nearly 41 per cent of the Government’s total budgetary receipts during 1957-63. But despite the substantial foreign aid, the growing requirements of defense and economic reconstruction aggravated the inflationary pressures. During 1953-63 the annual rate of increase in money supply and wholesale prices averaged 38 per cent and 21 per cent, respectively. It was not until late in 1963 with the election of a new Government that the authorities were able to initiate a resolute anti-inflationary program, which in its initial stages was concerned primarily with restraining monetary expansion and with extending the role of the price mechanism as a means of achieving a more efficient allocation of resources.43 For many years the Korean authorities had maintained statutory ceilings on interest rates that were substantially below free market interest rates and doubtless did not reflect the real economic cost of capital. One major effect of the unrealistic levels of interest rates was that “time and savings deposits of banks did not increase at all in real terms between December 1962 and September 1965 (before the interest rate reform) despite strong savings campaigns carried out by both government and financial institutions.” 44 Consequently, there was a drain of funds from the organized to the unorganized sector, which, according to one estimate, financed about one third of total outstanding loans in Korea.45

Apart from their unrealistic levels, the structure of interest rates in the organized sector suffered from an excessively complex and artificial differentiation of deposits by categories, maturities, and rates. There were about 11 classes of deposits with rates ranging from 0 to 1.8 per cent on “money” accounts and from 3.6 per cent to 16.8 per cent on savings accounts. It has been said that “so fine a distinction between accounts implies a knowledge by banking officials about the public’s elasticities of demand for deposits of different maturity, with slight differences also in some other characteristics, that must be fictitious.” 46 Thus, the situation clearly pointed to the need for raising interest rates to more realistic levels while simplifying their complex structure.

The Korean authorities announced a far-reaching scheme of interest rate reforms in September 1965.47 Its objectives were to raise deposit and loan rates to realistic levels to reflect the true economic cost of capital; to increase voluntary private monetary savings by providing adequately attractive “real” rates of return; to promote optimum allocation of savings in productive channels; to facilitate the shift in credit policy from specific and direct controls to global instruments; to attract funds from the unorganized sector (curb market) into the banking system, thereby extending and strengthening the area of effectiveness of the monetary authorities; to encourage the use of equity capital instead of borrowed capital by industrial and commercial firms; and to reduce the degree of “gearing” in the capital structure.

Accordingly, the Interest Restriction Law was amended by the National Assembly on September 14, 1965, and on September 30, 1965 the Korean Monetary Board raised the maximum permissible interest rates on deposits, loans, and discounts of commercial banks and the specialized financial institutions,48 money trusts, postal savings, and government funds. The Bank of Korea announced an increase in the rates on its loans and discounts, with effect from November 16, 1965, raising its basic rate from 10½ per cent to 21 per cent. Alongside these measures, the Monetary Board dismantled the extensive system of direct quantitative credit controls by abolishing, on September 30, the loan ceilings for individual banks and on specified uses of funds. Likewise, it abolished the “penalty” interest on central bank loans to banks that had exceeded their loan ceilings.

The actual ceiling rate on bank deposits was set at 2½ per cent a month, which was a little higher than the average yield on the government bonds (1.9–2 per cent a month) in the preceding few years but about one half of the rate prevailing in the unorganized sector (4–5 per cent a month), following China’s successful experience in this matter.49 As to loan rates, the authorities also adopted a pragmatic approach, in the absence of information on the interest elasticity of credit demand, in their search for a maximum rate that would not inhibit private investment. In the light of studies of the cost structure of various industries, it was estimated that the average cost of interest to industries would not increase if loan rates were set about 26 per cent per annum, on the basis that if borrowing from the unorganized sector was reduced because of the increased availability of bank credit at such a rate the incidence of increase in the average interest rate would remain largely unaffected and perhaps even be reduced in the long run. These studies also suggested the average rate of return on industrial capital to be about 20 per cent in real terms.50 Assuming that there would be an annual price rise of 7-10 per cent, an average loan rate of 26 per cent was regarded as reasonable, with a higher rate of 36½ percent for overdue loans to discourage the use of extended overdrawn positions to profit from the differential between the deposit and loan rates.

The sharp, dramatic increases in deposit and loan rates (see Table 14), in addition to the announced objectives, were intended to demonstrate clearly the determination of the authorities to curb inflation. Thus, the standard loan rate of banking institutions was almost doubled, increasing from 14 per cent per annum to 26 per cent. The presidential decree of September 24 laid a current ceiling of 36½ per cent per annum on interest rates in the organized sector. A ceiling of 40 per cent per annum was imposed on pecuniary loan contracts in the unorganized sector, and the maximum amount of loan subject to this law was raised from W 3,000 to W 5,000. The interest rates on time and savings deposits were also raised by about the same margin as the loan rates. The interest rates were raised on deposits with maturities of 3 months (to 1.5 per cent a month), 6 months (2.0 per cent), 12 months (2.2 per cent), and 18 months and over (2.6 per cent). In terms of annual interest the rise in the maximum interest on the one-year deposit was more than doubled, from 15 per cent to 34½ per cent. It is significant that the rates on long-term deposits were set on a monthly basis in accordance with the practice in the unorganized markets. This gave the depositors the option of either withdrawing the interest earned at the end of each month or accumulating it to have it compounded monthly. This feature was intended to give a sharper edge to the organized banking sector’s competition with the unorganized sector. Since the rates prescribed were intended as legal maxima, this meant that within the ceiling rate(s) each bank was free to fix its deposit rates by term structure and its loan rates by purpose, security, etc. In fact, however, all banks adopted uniform deposit and loan rates by an agreement of the Korean Bankers Association, mainly to avoid uneconomic interbank competition. Most banks increased the agreed actual rates to the maximum that was permitted under the law of September 30, 1965.

Table 14.

Korea: Selected Interest Rates of Banking Institutions, September 30, 1965-June 2, 1969

(In per cent per annum)

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Source: Bank of Korea, Monthly Statistical Review.

Commercial bank loans for imports of raw materials for earning foreign exchange carry an annual interest rate of 6 per cent, while the rate on loans for importing raw materials and industrial facilities for other purposes is 24 per cent.

April 1, 1968.

The revision on October 1, 1968 abolished time deposits of more than 18 months.

This deposit was abolished in November 1967. The revision on April 1, 1968 created a “new living” deposit, carrying annual interest of 12 per cent. The June 1969 revision lowered the interest rate to 9.6 per cent.

The banking institutions’ adoption of the ceiling rates on loans, which had been set by the Monetary Board, as the effective rates created a partially “inverted” rate structure; as the ceiling rate on general purpose loans was 26 per cent per annum, the loan rate fell below the maximum deposit rate. On the other hand, the fact that the average rate on all deposits was expected to be lower than the ceiling rate on general loans obviated the possibility of outright losses on banking business. But the authorities were mindful of the need to mitigate any possible adverse impact of interest rate changes on the profitability of banking operations. Accordingly, the Monetary Board took two major steps on September 30, 1965. First, it was decided that the Bank of Korea would pay interest at 3½ per cent per annum during the six-month period ending on March 31, 1966 on the portion of commercial bank reserves in the Bank of Korea that was equivalent to the individual bank’s holdings of time and savings deposits. There was also a provision to ensure that the interest payable by the Bank of Korea on commercial bank reserves against time and savings deposits was adjusted according to the extent of reduction in bank earnings.51 It was hoped that this system would encourage banks to seek to increase their private time and savings deposits so as to offset any adverse effects of the rate increase on bank profits.

Second, the Monetary Board also decided that the Bank of Korea would lend up to W 5 billion in emergency loans to business firms through banks upon their request. This step was taken to alleviate any possible difficulties faced by business firms (1) in the event of a possible shift of individual interest-bearing deposits from firms to commercial banks and (2) because of accelerated large-scale collections of overdue loans by banks.

But the range of application of the increase in the standard loan rate of commercial banks was restricted by the extensive system of preferential loan rates of interest, mostly for exports and for imports of raw materials by export industries. This was done by keeping the rate on export credit (against the collateral of export letters of credit) unchanged at 6½-7 per cent per annum, so as to afford greater incentives to exporters. This widened the differential between the rates on export credit and other credit.

The lower rate on loans from government funds was considered justifiable for attracting private investment in selected essential sectors. Another consideration was that the rate on long-term loans (of ten years and above) should be geared to long-term expectations on interest, since unilateral changes in long-term loan contracts between banks and customers were considered neither feasible nor desirable. This second consideration indicated that the high interest rate strategy was regarded essentially as a transitory program to cope with low monetary saving under inflationary conditions and that, with the attainment of a relatively stable price level, interest rates would decline to relatively normal levels.

The standard loan rate also did not apply to government-approved borrowing, whether private or official, from foreign sources. This, in a climate of domestic credit restriction coupled with the relative stability of the exchange rate since 1966 and the greatly reduced exchange risks, naturally led to a large expansion in foreign borrowing.

When allowance was made for these preferential rates and the exemption of foreign loans from the purview of the enhanced loan rates, the weighted average lending rate of commercial banks was estimated to be about 18-20 per cent. Likewise, the average money cost of borrowing for businesses was reduced to levels far below the standard loan rate of banks,52 and the real cost too was further reduced with the continued increase in prices. Thus, approximately one third of total commercial bank credit was extended at preferential rates (mostly to the export sector). At such rates, the bulk of the loans extended by specialized financial institutions, which amounted to about two to three times the volume of commercial bank credit, was intended as medium-term and long-term finance; but preferential loan rates were often applied to operational loans for working capital as well.

The narrowed differential between effective loan rates and deposit rates strained the profit position of banks without, however, putting them into deficit. Initially, this strain was not felt because of the preponderance of noninterest-bearing demand deposits and the relatively low reserve ratios applied to these deposits. Subsequently, the steady rise in the volume of time and savings deposits and concomitant increases in reserve requirements against them, in order to control liquidity generated by the external surplus, increased the pressure on bank profits. The monetary authorities therefore decided to subsidize banks for any possible loss by payment of interest (at 5 per cent per annum) on bank reserves for time and savings deposits and by special issues of three-month stabilization bonds of the central bank (at 10 per cent), which were also intended to absorb the excess liquidity resulting from increased foreign reserves.

In order to counter the rise in commercial bank credit after September 30, the basic rediscount rate of the Bank of Korea was raised on December 1, 1965 from 21 per cent to 28 per cent, which probably represents the highest central bank rate ever. The Bank of Korea raised commercial bank reserve requirements on March 1, 1965 and again on February 1, 1966. The Monetary Board abolished the special emergency loans to banks that had been introduced at the time of the reform. Commercial banks were required to purchase 91-day stabilization bonds, discounted at a rate of almost 5 per cent, so as to reduce the liquidity arising from heavy purchases of foreign exchange. Quotas for the purchase of these bonds were assigned to each of the five leading commercial banks in accordance with the percentage distribution of increases in required reserves and the expansion of loans (other than those exempted). The minimum capital/assets ratio of banks was also changed from one fifteenth to one twentieth to meet the situation created by the expansion in bank assets after September 1965.

Since the interest rate reform of September 1965, there have been three successive adjustments in the interest rate structure: on April 1 and October 1, 1968, and June 2, 1969. The first adjustment, which left loan rates unchanged, lowered some deposit rates in order to simplify the existing structure of deposit rates and to reduce to some extent the “inverse differential” between some deposit rates and bank lending rates. The second adjustment eliminated the inverse differential. But, in view of the continued increases in time and savings deposits, the third adjustment took the form of a general downward revision of deposit and loan rates. It was designed primarily to adjust interest rates to more normal levels, to realign interest rates with the prevailing rates of return on investment, and to reduce costs of bank finance for domestic enterprises.

The effectiveness of the high interest rate structure in October 1965 in stimulating saving is shown by the spectacular rise in monetary saving in 1966 (123 per cent) and 1967 (84 per cent). It is significant that even the lowering of interest rates on deposits in April and October 1968 did not affect the growth of monetary savings, which increased by 94 per cent in 1968. The increase in time deposits was at a higher rate than in other types of saving because of the more favorable rate and also because some categories of savings deposit, such as installment savings, could not be accelerated in the short run. The rise in quasi-money is indeed impressive, even though a part of the increase reflects the accrued interest that was withdrawable on demand. On the other hand, some of the rise in time deposits might represent merely a diversion of deposits previously held with nonbank moneylenders (the unorganized sector).

The bulk of the increase in time and savings deposits during 1964–68 was accounted for by the household sector. (See Table 15.) The presumption of interest sensitivity of household savings is also borne out by the results of a multiple regression analysis, which showed a strong correlation between the real deposit rate of interest and the savings of the household sector 53 as well as between gross private saving and gross domestic saving. On the other hand, the behavior of aggregate private savings (i.e., private savings as a percentage of GNP at current prices) was somewhat erratic (see the last column of Table 16) over the period 1962–68. On the whole, it may be conceded that the policy of realistic interest rates has improved the efficacy of the price mechanism in the organized money market in Korea. There are, however, no data to indicate its precise impact on the share of the unorganized sector in total finance. On the other hand, the high interest rates on domestically borrowed funds have also encouraged excessive borrowing from abroad. Since such borrowing requires the approval of government departments and specialized financial institutions, it has in effect created a system of administrative credit rationing. Equally, to some extent, the high rates have doubtless also stimulated an inflow of remittances from abroad. This only highlights some of the problems of an active interest rate policy in a comparatively open economy.

Table 15.

Korea: Changes in Holdings of Time and Savings Deposits, 1964-68 1

(In billions of won)

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Source: Bank of Korea, Monthly Statistical Review—based on Flow of Funds Account.

Includes insurance and trust deposits.

Table 16.

Korea: Nominal and Real Rates of Interest on Deposits; Quasi-Money; and Private Savings, 1961-June 2, 1969

(Rates in per cent per annum; amounts in billions of won)

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Sources: Bank of Korea, Monthly Statistical Review; International Monetary Fund, International Financial Statistics.

The real rate is adjusted for changes in consumer prices for all cities (1965 = 100).

April 1.

October 1.

End of 1968.

June 2.

While the interest rate policy in Korea has been notably successful in achieving its objectives, some of the concomitant factors that contributed to the result cannot be overlooked in an overall assessment. First, the achievement of overall balance in the government budget virtually eliminated the need for domestic borrowing, except for temporary accommodation from the Bank of Korea. Consequently, the need to keep down the cost of government borrowing ceased to be an inhibiting factor in raising interest rates. Second, the comparatively small ratio of financial assets to total national wealth meant that capital losses, as a result of interest rate increases, were not a material consideration. Third, because, as in China, government and semigovernment institutions account for a substantial part of commercial banking, the implementation of the reforms was that much easier. Other contributory factors included the active savings campaign of the Government, the lack of alternative financial assets to bank deposits offering comparably attractive rates, and the exemption of deposit interest from income tax. Thus, interest rate policy, although important, was only one element in the overall stabilization program, which comprised appropriate budgetary, credit, and exchange policies.

The interest rate reform of September 1965 is, in retrospect, best viewed not as a once-for-all, high interest rate strategy but as an avowedly transitional phase, since the authorities have steadily endeavored to normalize the interest rate level and structure by progressively reducing and simplifying the general level of rates with the restoration of financial stability. The attainment of price stability has, however, ensured the maintenance of positive real rates of interest.

A conventional interest rate policy (Malaysia and Singapore)

In contrast to the high interest rate strategies in China and Korea, the experience of high and rising levels of monetary savings in Malaysia and Singapore, despite low and stable nominal interest rates, is equally instructive—not least because of some other distinguishing features of these economies.

First, even before they accepted the obligations of Article VIII, Sections 2, 3, and 4, of the Fund Agreement—Malaysia on March 11, 1968 and Singapore on November 9, 1968—both countries had virtually free and open economies not only in respect of current payments but also for capital transfers within the sterling area. This situation presents investors in these two countries with a choice between domestic and sterling area assets, such as bank deposits, securities, and treasury bills. Likewise, in Malaysia, the Government has floated external market loans. Thus, both the Government and the private sector in these two countries have an effective choice between borrowing and investing at home or abroad.

Second, as the present arrangements between Malaysia and Singapore permit interchangeability of currencies and free movement of bank funds and also provide for a joint agreement on (maximum) deposit rates and (minimum) advance rates through the Bankers Association of Malaysia and Singapore, the short-term money market is virtually interdependent; therefore, short-term rates cannot diverge too much, except perhaps treasury bill rates. Coupled with the existence of a common stock exchange for Malaysia and Singapore, this creates a common capital market as well, to some extent.

Third, in both countries the bulk of the domestic marketable public debt is held by the Employees’ Provident Fund, which assures the respective Governments of a large and growing captive market for medium-term and long-term securities. The situation in Malaysia and Singapore is particularly relevant for examining the scope for an interest rate policy in open economies and the rationale of low and stable rates on monopsonistic government borrowing.

Since in both Malaysia and Singapore investors enjoy freedom of current payments and for capital transfers within the sterling area, the question arises as to how far such economies should take account of movements in external interest rates. To some extent the exchange risk might be a deterrent to any abnormal outflow of capital. But because the bulk of investible funds in Malaysia and Singapore is institutional (e.g., the Employees’ Provident Fund and other trustee funds), and by law, convention, and economic necessity has to be invested mostly within the countries, the area of effective choice is narrowed between domestic and external assets. It is even doubtful whether other funds that are not subject to those considerations would seek external outlets to any great extent. Significantly, despite the civil disturbances in May 1968, hardly any investible funds left Malaysia, an indication of the average investor’s confidence in the stability of the currency and the economy. Admittedly, some movement of “hot money” is possible in any open economy, but most countries would not be too eager to adopt higher interest rates in order to discourage such movements. Besides, no matter how high domestic rates of interest are, they are unlikely to deter outflows of hot money, which are a function of “confidence” and other (noneconomic) factors as much as of yield.

The fact that both Malaysia and Singapore have been able increasingly to adopt an autonomous interest rate policy on their treasury bills, in contrast to the earlier tendency to follow the U. K. treasury bill rate, shows that the openness of an economy need not be a constraint on an autonomous policy geared to local needs. The development of increasingly active local treasury bill markets has created a convenient outlet for short-term banking funds that were formerly invested in U. K. treasury bills. The higher rates of interest (7–7½ per cent) on Malaysia’s foreign loans compared with those (5–6¼ per cent) on domestic loans reflect the fact that the market conditions and objectives of the two types of loan are totally different; foreign loans are raised primarily to meet the foreign exchange costs of development programs and ought not to be regarded merely as substitutes for domestic savings. There is therefore no reason to assume any necessary interdependence between interest rates on domestic and external market loans.

The structure and level of deposit and loan rates of interest in Malaysia and Singapore (Tables 17 and 18) as well as the nominal rates on government securities (up to 6½ per cent) are of a comparatively low and stable character in contrast to those of China and Korea. They therefore represent a more conventional pattern of interest rates commonly found in economies that have not experienced violent economic fluctuations. Thus, apart from the fine and fairly frequent variations in the treasury bill rate, other rates have been remarkably stable over long periods. The explanation for this may be sought in the fact that the volume of monetary savings in both countries has risen impressively despite the low and stable interest rates (Table 19). This reflects in large part the confidence of the average investor in the stability of the value of monetary assets that has resulted from his experience with prolonged stability of consumer prices, which in turn is due to a variety of factors, such as the openness of the economies and the appropriateness of financial and wage policies. The depositor therefore has been able to earn a real rate of interest at least equal to the money rate and in some years even higher than that, owing to the fall in prices. Significantly, deposits have maintained their rise even in years when the real rate was negative.

Table 17.

Malaysia: Interest Rates on Fixed and Savings Deposits and Private Savings, 1959–69

(Rates in per cent per annum; amounts in millions of Malaysian dollars)

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Sources: Bank Negara Malaysia, Annual Reports and Quarterly Economic Bulletin.

The nominal rates in 1959 were 3.50 per cent for the 3–6 month deposits and 3.75 per cent for the 9–12 month deposits; the rates for 3–12 month deposits were 4.00 per cent for the period 1960–63 and 5.00 per cent for the period 1964–66; in 1967 and 1968 the fixed deposit rates were made to vary with the length of deposit, from 5.50 per cent for the 3-month deposits and 5.75 per cent for the 6-month deposits to 6.00 per cent for the 9–12 month deposits. Since 1964 the deposit rates for one month have been fixed at 2.50 per cent for the period 1964–66 and at 3.00 per cent for the period 1967–68.

As adjusted by the retail price index (1959 = 100). Minus sign indicates negative real rates.

At the end of period.

Mid-term review of the First Malaysian Plan, 1966–70 (figures for 1968 are preliminary).

Table 18.

Singapore: Structure of Interest Rates, December 31, 1966-April 20, 1970

(In per cent per annum)

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Source: Data provided by Singapore authorities.

The minimum amount of deposit is S$25,000.

Applies to advances to Government and public authorities; and advances against local agricultural products.

November 22.

March 23.

Table 19.

Malaysia and Singapore: Quasi-Money, 1960–70

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Source: International Monetary Fund, International Financial Statistics.

More or less similar considerations apply to the pattern of interest rates on government securities because of the positive real rates of interest on them (Table 20). Because about 80 per cent of the total marketable public debt is held by tax-exempt “captive” funds (required by law to be invested in government securities), such as the Employees’ Provident Fund and other trust funds and the Post Office Savings Bank, the Government is assured of progressively rising support from investors even at stable interest rates. In view of this, paying higher interest on funds that would flow into gilt-edged stock would add needlessly to the cost of debt service. Although the debt service burden is not a decisive argument against higher (realistic) interest rates on government loans, at least two possible considerations might argue against excessive rigidity of existing yields on government securities. The first is the “equity” argument that the Government should not unduly exploit its monopsonistic position as a borrower. Moreover, pension and social security funds in many countries are increasingly diversifying their portfolios by investing in high-yield, first-class equities to offset the low nominal yields, as well as depreciation in real terms, of gilt-edged stock. Consequently, the availability of a large and growing captive market in Malaysia and Singapore in itself need not preclude examination of the adequacy and equity of the real rate of return to the investor in government securities, even though this has been positive in the past decade. These considerations are, of course, equally applicable to other developing economies.

Table 20.

Malaysia: Nominal Interest Rates on Government Securities, July 27, 1959–April 6, 19701

(In per cent per annum)

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Sources: Bank Negara Malaysia, Annual Reports.

Real rates as adjusted by the retail price index (1959 = 100) are shown in parentheses.

Treasury bills are also issued for 6 months, 9 months, and 12 months; discount rates on April 6, 1970 were 5¼ per cent (on 6-month bills), 5⅜ per cent (9-month), and 5½ per cent (12-month).

Refers to dates of change in the rate from the previous level.