Can Low Interest Rates Erase Debt: From RMB, Japan to Financial Repression

Mon, 27 Jul 2026 20:36:55 +0800

Is China using low interest rates to “resolve its debt”? This assessment is half straightforward: with low interest rates, debtors pay less in interest each year, and the rollover pressure on the government and local government financing vehicles eases. The other half, however, is easily overstated: low interest rates do not mean the principal of the debt has disappeared, nor do they automatically mean that household deposits are filling the government’s holes.

To understand this clearly, we first need to separate four things that are often conflated: the policy rate, the real rate, the exchange rate, and capital flows.

First, let me correct a premise: the RMB has not appreciated continuously over the past five years

If “appreciation” refers to the nominal exchange rate against the U.S. dollar, the past five years have not been a continuous line of appreciation, but rather have shown distinct periodic fluctuations. The RMB exchange rate against a basket of currencies is not the same indicator as the exchange rate against the U.S. dollar. Going one step further, the implications of exchange rates for trade competitiveness and purchasing power also depend on the inflation differential between China and other countries.

The IMF, in its 2025 Article IV consultation with China, emphasized a phenomenon that differs from the notion that “the RMB has been continuously appreciating”: because China’s inflation is lower than that of its trading partners, the real exchange rate has depreciated, which has helped boost export growth. The State Administration of Foreign Exchange’s 2025 Balance of Payments report showed a current account surplus of US$735 billion, accounting for 3.7% of GDP, and stated that the RMB is basically stable at a reasonable and equilibrium level. Together, they remind us that low interest rates, trade surpluses, and periodic currency strength can occur simultaneously, but this does not warrant the conclusion that “one policy deliberately engineered another outcome.”

Capital account management should not be simplistically translated as “blocking capital outflows.” China’s capital account is not fully freely convertible; cross-border funds are subject to authenticity, compliance, and macroprudential management requirements, which affect the speed and channels of capital outflows. However, current account surpluses also naturally generate external asset allocation. The State Administration of Foreign Exchange’s (SAFE) description for 2025 is precisely this: capital inflows formed by current account surpluses are converted into outward investments under the financial account. The existence of management does not mean that every external allocation is prohibited; it is more akin to a set of valves rather than a one-way plug.

How Low Interest Rates Help “Resolve Debt”

Start with the simplest layer: the interest bill on debt. In May 2025, the 1-year LPR fell to 3.0%, and the over-5-year LPR fell to 3.5%. For floating-rate loans, newly issued debt, and debt being refinanced at maturity, lower rates will gradually reduce financing costs. This is also the main role of local implicit debt swaps: replacing short-term, high-interest, cash-flow-pressured debt with longer-tenor, lower-cost, and clearer-credit debt. The IMF’s characterization of this round of implicit debt swaps—five trillion yuan over five years starting in 2024—is “easing refinancing pressure.”

But “alleviating the pressure” is not the same as “eliminating the debt.” When looking at the debt ratio, an approximate relationship is quite useful:

$$ \Delta d_t \approx \frac{r-g}{1+g}d_{t-1}-pb_t $$

Here, $d$ is the debt-to-GDP ratio, $r$ is the average nominal interest rate, $g$ is the nominal GDP growth rate, and $pb$ is the primary fiscal surplus (revenue minus non-interest expenditure, with surplus being positive). A low $r$ suppresses the first term; higher nominal growth $g$ and a sustained primary surplus $pb$ also help bring the debt ratio down. Conversely, if nominal growth is weak and the government runs persistent large deficits, low interest rates alone can only drag the problem out longer and smooth it over—they cannot make the arithmetic disappear.

This is also why real estate adjustments, local government finances, and low inflation make the problem harder: low inflation suppresses the nominal GDP growth rate, so the denominator no longer grows quickly; although bond yields are low, $r-g$ may not be favorable enough.

Are Depositors Being “Silently Devalued”

This requires distinguishing between low nominal interest rates and negative real interest rates:

$$ \text{Real Interest Rate} \approx \text{Nominal Deposit Rate} - \text{Inflation Rate} $$

If the deposit interest rate is 1% and inflation is 3%, the real purchasing power return for savers is approximately -2%; debtors repay with lower real costs, and the real value of government debt is also eroded by inflation. This is close to a mechanism of “using savers’ purchasing power to reduce historical debt.”

In academic literature, this entire set of institutional arrangements is often referred to as “financial repression.” The typical characteristics listed by Reinhart and Sbrancia include: constrained domestic funds absorbing government debt, explicit or implicit interest rate ceilings, restrictions on cross-border capital flows, and closer ties between the government and the banking system. Low nominal interest rates save on interest expenses; only when a negative real interest rate forms over the long term does the “liquidation” effect they describe occur, in which the real value of debt is eroded.

However, applying this label to China in recent years requires particular caution. First, low inflation or even falling prices raise real interest rates rather than produce persistently negative real rates; a decline in nominal deposit interest does not necessarily translate into a proportional decline in the purchasing power of deposits. Second, households hold more than deposits; housing, wealth-management products, equity assets, and employment income are also affected by macroeconomic adjustments, so the distributional consequences cannot be captured by deposit interest rates alone. Third, observing capital flow controls, a high share of state-owned banks, and low interest rates only shows that they resemble certain elements in the definition of “financial repression”; this does not prove that the sole intent of any given policy is to tax households.

There are also two related but distinct words:

Term	Core Meaning	Conclusion That Cannot Be Directly Drawn
Financial Repression	Using regulation, interest rates, capital allocation, etc., to keep domestic financing costs lower than what a free market might provide	Any interest rate cut constitutes financial repression
Debt Monetization	The central bank directly or indirectly and continuously provides monetary financing for fiscal deficits	A central bank rate cut or bank purchases of government bonds necessarily constitute monetization
Fiscal Dominance	Fiscal sustainability in turn constrains monetary policy, making it difficult for the central bank to act solely according to inflation targets	High debt alone means monetary policy independence has already been lost

Mixing up these three terms often turns reasonable questions into already-verified conclusions.

Japan Followed a Similar Path, but Not the Same Script

Japan is indeed a good reference for understanding persistently low interest rates. The Bank of Japan (BOJ) began its zero interest rate policy in 1999 and moved into quantitative easing in 2001; in 2016, it introduced negative interest rates and yield curve control (YCC), targeting the long-term rate near zero. In March 2024, the BOJ judged that negative interest rates and YCC had fulfilled their roles and ended this framework, returning the short-term rate to its primary policy instrument.

Japan’s starting point was low growth, deflationary pressure, and the repair of its banking system following the collapse of an asset bubble. Persistently low interest rates objectively lowered the cost for the Japanese government to roll over its massive government debt, and high domestic savings combined with domestic financial institutions holding Japanese government bonds also made its financing structure more stable. However, this is not sufficient evidence that “the Japanese government intentionally let savers lose value to reduce its debt.” Japan’s long-term inflation was very low, with deflation in many years, so negative real interest rates were not stable. A more accurate way to put it is that Japan demonstrated how a highly indebted economy can extend its adjustment period by relying on domestic-currency financing, low interest rates, and a strong base of domestic investors; it also demonstrated the costs—bank profitability, distorted asset allocation, fiscal dependence on low interest rates, and the difficulties of exiting monetary easing.

The commonality between China and Japan is that both face high savings rates, banking systems of significant importance, debt rollover pressures, and low interest rates. The differences are equally critical: China still has higher potential growth space, a greater degree of capital account management, a different exchange rate mechanism, and a greater weight of local governments and the real estate sector in the debt chain. Therefore, “China will become Japan” is a hypothesis that requires continuous testing, not a prediction that can be established by the single variable of low interest rates.

What sustains this arrangement, and where does it break down

If an economy uses low interest rates to help roll over debt over a long period, it needs at least five pivot points:

Sufficiently large domestic savings and investors willing to hold local-currency-denominated assets, avoiding excessive reliance on foreign debt.
The banking system, insurance, pension funds, and bond markets are able to absorb longer-term government and quasi-government debt while remaining well-capitalized and with identifiable risks.
Nominal growth ultimately exceeds the average cost of financing, or the fiscal position can achieve a sustainable improvement in the primary balance; this is more fundamental than simply “suppressing interest rates.”
A credible balance is maintained among inflation, the exchange rate, and capital flows. If interest rates are too low while exchange-rate expectations become destabilized, evasive outflows may be induced; the tighter the controls, the more transparent and predictable rules are needed to maintain confidence.
Beyond debt rollover, there must be genuine fiscal and balance-sheet adjustments: clarifying who bears legacy debt, shutting down financing vehicles that lack cash flow, and restoring local tax sources and social security—rather than repeatedly renaming old debt.

The warning signs are equally intuitive: nominal growth consistently falls short of financing costs, banks see their capital erode as they absorb the debt, depositors shift into avoidance channels, exchange-rate expectations become one-sided, or fiscal authorities rely solely on rollover rather than addressing unsustainable debt. At that point, low interest rates are no longer a buffer but instead expose the fragility of an economy that “cannot afford interest-rate normalization.”

So, the shortest answer to the original question is: low interest rates are indeed one of the tools available to defuse debt pressures, especially by reducing rollover costs; however, they are not an independent debt solution. A situation resembling “financial repression”–style debt dilution only emerges when sustained negative real interest rates, constrained funding absorption capacity, and a degree of inflation all coexist. China’s low inflation in recent years means instead that the continuous erosion of depositors’ purchasing power through inflation cannot be treated as an established fact. What really determines how far this path can go is not whether interest rates can be cut a little further, but whether the economy can return to nominal growth, whether fiscal policy can transform implicit debt into manageable explicit obligations, and whether households are still willing to hold domestic-currency financial assets.

References

People’s Bank of China: Chronology of China’s Monetary Policy in the First Three Quarters of 2025, accessed: 2026-07-27.
State Administration of Foreign Exchange: China’s International Balance of Payments Report 2025, accessed: 2026-07-27.
IMF: People’s Republic of China 2025 Article IV Consultation, accessed: 2026-07-27.
Reinhart & Sbrancia: The Liquidation of Government Debt, accessed: 2026-07-27.
Bank of Japan: Unconventional Monetary Policy since the Latter Half of the 1990s, accessed: 2026-07-27.
Bank of Japan: Adjustment of the Monetary Policy Framework in 2024, accessed: 2026-07-27.

写作附记

Writing Instructions

This article discusses macro-financial mechanisms and publicly available materials, and does not constitute investment, currency exchange, or asset allocation advice. Regarding policy intentions, only verifiable measures and their possible mechanisms are stated, and relevance is not equated with the sole motive.

Original Prompt

In the past five years, China has entered a low-interest-rate mode, but the RMB has been appreciating in tandem, while various measures have been taken to intercept capital outflows. Is China using lower interest rates to resolve government debt issues? Is it equivalent to allowing the slow depreciation of household deposits to resolve historical debt? Has Japan ever taken this path? What is this called in economics? Explain the corresponding basic economic knowledge and what is needed to sustain this model’s operation?

Japanese Economy on Uncle Xiang's Notebook