• Thu
  • Dec 18, 2014
  • Updated: 2:53am
BusinessBanking & Finance

Reserve ratio to play bigger role in China's monetary policy

Beijing will rely more on adjusting the ratio to counter a slowdown, with rate controls in flux

PUBLISHED : Saturday, 26 April, 2014, 1:21am
UPDATED : Saturday, 26 April, 2014, 1:21am

Beijing's relaxation of interest rate controls has left cutting banks' required reserves as the chief monetary tool to counter a slowdown, focusing attention on an option used in the past decade only during financial crises.

Premier Li Keqiang's insistence that the mainland would not implement more powerful stimulus than faster spending on railways and reserve ratio cuts for rural banks has failed to sway economists, who predict the central bank will lower the ratio nationwide this year. The tool unleashes about US$80 billion of liquidity into the system for every half-percentage-point cut.

The mainland has put its interest rate system in flux with last year's removal of limits on borrowing costs and a shift towards interbank market rates. That has left officials reliant on the reserve ratio tool if they need to call on monetary policy to support growth even as they seek to give markets a greater role and rein in surging debt.

"The changing regime means the reserve ratio has a more material impact because it impacts liquidity in the interbank market," said Yao Wei, China economist at Societe Generale. "That changes the interest rates that actually matter."

Beijing last lowered reserve ratios during the depths of the European debt turmoil, when three cuts were made from November 2011 to May 2012. Reductions had also coincided with periods when capital had flowed out of the country, said Michael Pettis, a finance professor at Peking University in Beijing.

The government had used increases in the ratio as an "industrial-sized vacuum cleaner" to soak up liquidity when the nation faced a balance-of-payments surplus or was buying US dollars to prevent the yuan from appreciating, said David Loevinger, former US Treasury Department senior co-ordinator for China affairs and now an analyst at TCW.

Mainland authorities are transitioning from a system of state-directed credit to one where markets play a "decisive" role in pricing capital. A floor was removed from lending rates in July and People's Bank of China governor Zhou Xiaochuan said deposit rates would be liberalised in one to two years.

Beijing has increasingly used tools including repurchase agreements to manage liquidity in the financial system and influence interbank rates.

"The PBOC is struggling to find a new framework for monetary policy and what's the best rate to target," said Shen Minggao, head of China research at Citigroup.

Xu Gao, chief economist at Everbright Securities, said policymakers would prefer to cut the reserve ratio over interest rates because reducing the ratio could release money into the system while influencing expectations.


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Concerning the coming political setup, Carrie Lam today jokingly asks some people in Hong Kong to 'give her a sidewalk to pass through.'
I think, those people are very seriously, not jokingly, and of course implicitly, asking her the very same question !
Voluntary exchange is mutually beneficial, in economics at least.
About politics, it's said that an economist doesn't have much to say --- perhaps this is true.
China's 4-trillion-yuan investment binge in 2008 has unintentionally made some SOEs much more powerful than before, now threatening the very existence of some of the country's private enterprises.
If those SOEs are now privatised, dozens of mega-sized oligarchs may prop up in China, each controlling massive amount of wealth, and, without effective restraints, may even collude to affect the policies of the central government, like Russia's 8 big oligarchs.
I can't resist imagining the seemingly similar situation here in Hong Kong, where ...
'I'm gonna make him an offer he can't refuse.' --- Godfather.
To solve the present political deadlock, the Hong Kong government can make an offer some of those democratic bulldogs can't refuse, in exchange for their compromise over the future political arrangements --- they are going to head the coming anti-trust commission in the territory.
The society's anger, if any, can be directed away from the government in one stroke.
According to Zhang Jun (Fudan University),
in 1998, facing the Asian Financial Crisis, China also practised expansionary policies to stimulate internal demand,
but the monetary policy at that time was relatively stable, a bit tight actually.
There was no massive growth in credit.
Still, the country continued to grow relatively smoothly, without experiencing big ups and downs.
The repeated economic crises of the 1990s and 2000s in the US has taught us at least a lesson: there are no miraculous shortcuts to economic growth.
There are certainly no grounds for allowing monetary and regulatory policy to be hijacked and held in an excessively accommodative position by a government’s need for maintaining the country’s GDP and employment growth.
(adapted from ‘Unbalanced: The Codependency of America and China’ by Stephen Roach)
And the unintended aftermath of China’s recent 4-trillion-yuan investment binge certainly confirms once again the above point of view.
Note that a trillion yuan means a million million yuan (one followed by 12 zeros) !
Of the 4 trillion yuan, about 1.2 trillion was fiscal expenditure,
the rest, through the financing vehicles, probably supported a total of 20 trillion yuan of credit.
That's why China's M2/GDP ratio is so high at present.
After one and a half years, the Chinese government had to quickly step on the brake to cool down the overheated economy.
This partly explains China's coma stock market in recent years.
Firstly, if their repayment ability is unreliable, the LGs’ reputation will be further hurt, making them more difficult to obtain loans in the future.
Secondly, if the debts of the LGs are ultimately guaranteed by the central government (CG), this will also hurt the credibility of the CG.
Thirdly, if the loan money is not spent efficiently (say, used to build those palace-like LG offices), scarce capital resources will further be wasted.
Fourthly, some incumbent LG officials rely on their counterparts in the next term to repay their debts (translation: the debts won’t be repaid). The banks’ bad loans may further increase, thereby hurting the stability of the whole banking system.
(From the Chinese book ‘China’s economic and social problems’ by Gregory Chi-Chong Chow)
It’s by no means certain that a lower reserve ratio in the future can benefit China’s overall economy.
If the bank money is mostly lent out to those inefficient SOEs, there may be more overcapacities and accumulated bad debts in the future.
And part of the money so obtained by the SOEs may ultimately be channeled to the local governments (LGs) --- through the SOEs' buying (renting actually) of the land put forward for development by the LGs.
For those LGs’ infrastructure projects and the like, the maturity mismatch problem is always there.
The loan repayment ability of those LGs is regarded as unreliable, and there is no guarantee that the fund they obtain will be used in the most efficient manner.


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