Freeing interest rates
Synonyms: Decontrolling interest rates
Transferring to market-determined interest rates
Relaxing interest rate controls
Context: In a majority of developing countries, governments control at least some interest rates to encourage investment in some sectors. Interest rate controls also help governments finance their budget deficits: many state owned enterprises rely on low-interest loans from the banking system, and many governments require banks to buy low-yielding government bonds or place some of their assets in low interest reserves with the central bank. Many governments are convinced of the need for reform, but are concerned about the transition to market-determined interest rates which is easier to manage when inflation is low and real exchange rates are stable. The speed of reform is an important factor, as interest rates need to rise slowly to reduce disruption to investors - too precipitous a rise would push many firms into insolvency and threaten the solvency of the banking system itself. At the same time, controls need to be lifted sufficiently fast for loans based on expected post-reform rates not to be postponed indefinitely.
Counter Claim: Once interest rate controls are relaxed, nominal and real interest rates in the formal sector are likely to rise; in some cases the post-reform lending rates may exceed the real rate of return on industrial investment. This may threaten growth and jeopardize the trade reforms that seek to change the structure of industry.
Type Classification: D: Detailed strategies