SINGAPORE: In its latest attempt to bolster a slowing economy, China’s central bank lowered the amount of cash that banks must hold in reserve, or the reserve requirement ratio (RRR), by 50 basis points on Monday (Feb 29).
The surprise cut, which came into effect on Tuesday, marked the fifth reduction that the People’s Bank of China (PBOC) has made to the RRR, which now stands at 17 per cent. The central bank last cut the RRR in Oct 2015, when it also lowered its benchmark interest rate by 25 basis points to rein in financing costs for heavily indebted firms.
In reaction to the latest easing move, Chinese equities finished nearly 2 per cent higher on Tuesday, but not without some volatility as cautious sentiment prevailed earlier in the day after two surveys of factory activity highlighted persistent sluggish conditions in the world's second-biggest economy.
WHAT IS THE RRR? It refers to the share of customer deposits that lenders must set aside as reserves. A rise or cut in the ratio will allow the central bank to reduce or increase liquidity available in the economy, with the latter usually designed to boost consumer spending and capital investment.
China’s RRR is notably higher today than it was more than a decade ago, as RRR hikes were used to curb surplus liquidity when the country’s rapid economic expansion attracted high levels of foreign investments, according to Goldman Sachs analysts.
Now, as China’s gross domestic product (GDP) slows to a 25-year low of 6.9 per cent in 2015, the latest cut in reserve ratio is expected to free up an estimated 700 billion yuan (US$107 billion) in funds for banks to make loans.
"The aim clearly is to support the economy at a time that downward pressures on growth remain strong and uncertainty is elevated," said Louis Kuijs, chief Asia economist at research firm Oxford Economics.
WHAT PROMPTED THE CUT? A confluence of factors, ranging from signs of increasing tightness in the money market, steep losses in equities which took stock bourses down to fresh 15-month lows on Monday and this week’s annual political events – the China People’s Political Consultative Conference (CPPCC) and the National People’s Congress (NPC).
Meanwhile, the reserve ratio cut, which came sooner than some analysts had expected, was also said to be a move to pre-empt of the official purchasing manager’s index (PMI) for February, which showed the country's manufacturing activity contracted for a seventh straight month.
“The timing may be explained by the maturing obligations of the money market, namely the 1.16 trillion yuan injected before the Lunar New Year that will mature this week, and we assume that they deem more liquidity support is needed,” said Tim Condon, head of Asia Research at ING Financial Markets. “They may also have had advanced notice of the PMI this morning and that (contributed) to the timing of the Feb 29 announcement.”
Both the official and private surveys of China's manufacturing activity deteriorated in February. (REUTERS/China Daily)
MORE TO COME? As China’s economy continues to lose growing momentum, it is largely expected that Beijing will ramp up stimulus to avert a deeper economic slowdown.
According to IG’s market strategist Bernard Aw, policy makers will likely be more inclined to adopt RRR cuts to avoid exacerbating capital outflows, a problem that China is already struggling with. Data from the Institute of International Finance showed that China experienced almost US$700 billion worth of capital flight in 2015.
“Capital outflows remain a concern so cutting interest rates will worsen the problems, whereas if you use the RRR policy tool, it will have a lesser impact on outflows. Given the weak PMI numbers, there is still room for more RRR cuts,” the Singapore-based analyst said.
Other economists expect Beijing to do more. Citi analysts, for instance, expect the PBOC to announce four additional 50-basis-point RRR cuts, alongside two 25-basis-point reduction to the benchmark policy rate this year.
Meanwhile, ING’s Mr Condon expects an interest-rate cut to be announced as soon as this weekend, in conjunction with the NPC meeting.
However, the effectiveness of China’s monetary stimulus remains uncertain. According to HSBC’s head of Hong Kong and China equity research Steven Sun, conventional policy easing which has seen the PBOC cut the RRR by 300 basis points and the benchmark rate by 165 basis points since Nov 2014, has done little to resuscitate the economy.
Instead, it has resulted in uneven impact across different asset classes. Property prices, particularly in tier-one cities, have jumped over 30 per cent on average as of January.
WEAKER YUAN ON THE CARDS? While additional easing measures are necessary to support growth, they could also exert fresh downward pressure on the Chinese yuan and contradict the PBOC’s goal to maintain a stable currency.
As such, the central bank issued a stronger guidance prior to the market open on Tuesday, setting the midpoint rate higher at 6.5385 per dollar, allowing the yuan to firm against the dollar.
“More easing from the Chinese government will put pressure on the Chinese yuan, but as we've seen from the yuan fixing, it reflected the PBOC's intention to ensure a stable yuan and this will be positive for market sentiment going forward,” IG’s Mr Aw told Channel NewsAsia. “But whether it will depreciate more, it will depend on the outflow dynamics and the depletion of the foreign exchange reserves in the coming months.”