A test of nerves

The bold monetary experiment that the Chinese and Indian central banks engaged in this year might one day be hailed as a success. So far, the result has been unprecedented market volatility and little else.

Both central banks targeted interbank rates to control the supply of money, aiming for a more surgical monetary tool than orthodox bank reserves or policy interest rates.

The People's Bank of China and the Reserve Bank of India were worried that sticking with traditional policy rates or bank reserves would have had a greater impact on the overall economy and slowed growth.

"They shifted to a more interest-rate-based system in both cases. Both central banks should be applauded for doing that," said Frederic Neumann, co-head of economic research at HSBC.

Both central banks are looking to liberalise their markets, but they are adopting a similar policy strategy in very different situations and for different reasons.

China is now using its open-market operations almost exclusively to try to rein in a credit binge. Apart from growth concerns, the PBOC feared that raising policy rates or reserve ratios would have added unwelcome fuel to a rally in the yuan.