Interest rates stifle small firms

China's inflation escalated to the highest level in three years, with the consumer price index (CPI), the main gauge of inflation, jumping 6.4 percent year-on-year in June. Chinese leaders have vowed to give priority to combating inflation. To contain China's stubbornly high inflation, the central bank has raised the benchmark interest rates three times this year, including the latest rate hike of 25 basis points announced on July 6.

However, the bold moves to tame inflation are driving small companies out of business. Companies that were successful and profitable are struggling as their costs of borrowing soar. To help them survive, as strange as it may seem, benchmark interest rates should be raised much higher.

Companies wanting to borrow money in China currently operate in a two-tier system. Those that can borrow from commercial banks are typically large scale and well connected, and include most State-owned enterprises (SOEs). Their cost of borrowing has been low - consistently lower than in India or Brazil - for example, over most of the past decade, even when differences in inflation are taken into account.