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No stock rally expected following China’s fresh easing signals

Stabilised yuan allows room for monetary loosening but high leverage across the economy constrains fiscal strength

PUBLISHED : Friday, 04 March, 2016, 3:51pm
UPDATED : Friday, 04 March, 2016, 3:51pm

China’s latest monetary easing policy in the form of a long overdue cut in banks’ reserve requirement ratios this week is unlikely to spark a stock market rally, while the stable performance of the yuan before and after the move indicates there is more room for further easing, say analysts.

The People’s Bank of China (PBOC) announced a 50 basis points reserve requirement ratio (RRR) cut for bank deposits on Monday night, the first broad-based RRR cut since last October, releasing around 700 billion yuan (HK$830.76 billion) in base money supply, according to analyst estimates. The consensus is that the central bank will make further cuts to RRR as well as benchmark interest rates.

Over the past several months the PBOC has been reluctant to carry out major reserve ratio cuts or interest rate reductions as it sought to curb speculation over a weaker yuan.

Instead, ahead of the Chinese New Year it adopted a record-setting capital injection strategy through open market operations (OMO), but still failed to quench the market’s thirst for long-term capital.

“Now that exchange rate concerns and pressures have eased somewhat versus the Chinese New Year, the PBOC appears to be sending a clearer signal of monetary policy accommodation,” UBS economists wrote in a note on Monday. “We expect more detailed measures to come, including the new budget to be unveiled at the annual National People’s Congress this weekend, on the monetary, fiscal and structural fronts.”

Economists with Goldman Sachs took the cut as “a clear signal”, amid significant confusion about the policy stance recently, that monetary policy has loosened, as hinted by Zhou Xiaochuan, governor of China’s central bank during the G20 meetings in Shanghai in late February. But the speed and scope for loosening seem largely confined by the economy’s high leverage status.

“The move is an indication that the overall bias is still towards loosening policy, but only modestly so. The reluctance to loosen more aggressively is likely related to concerns about leverage and a likely further rise in CPI inflation,” Goldman Sachs wrote in a note on Tuesday.

Hong Hao, chief strategist with Bocom International, said the RRR cut was to offset the decline in foreign exchange reserves as capital outflows continue amid the central bank’sover 1 trillion yuan in open market operations (OMO) facilities this week.

The mainland’s benchmark Shanghai Composite Index advanced 1.68 per cent on Tuesday and rallied another 4.26 per cent on Wednesday, following the RRR announcement. But Hong said the rally could not be sustained.

“China’s GDP monetisation rate, debt burden and housing inventory are at their extremes, and represent macro constraints on China. The support on property will not translate into investment growth immediately, but will render an even larger property excess, diverting liquidity from stocks,” he wrote in a note on Monday.

“The relative strength in rate-sensitive sectors’ prior to the announcement suggests that the market has been anticipating the cut. Shanghai’s bearish trend is yet to inflect, and any fleeting rebounds are opportunities to derisk,” he added.

Analysts with Goldman Sachs said the RRR cut may boost market sentiment in the short term, given it is the first major monetary easing since October 2015, “against a corrective and arguably short-term oversold market backdrop”.

However, the market return trajectory will likely stay challenging in the medium term, mainly due to liquidity concerns based on the regulators’ newly imposed restrictions for selling by major shareholders, shrinking in margin financing volume, and the still high valuation levels of small-to-mid caps.

The move is an indication that the overall bias is still towards loosening policy, but only modestly so
Goldman Sachs report

Meanwhile, in the currency market China’s onshore and offshore yuan stabilised around the level of 6.5 against the US dollar in February after the PBOC boosted it from historical lows amid strong devaluation expectations.

Offshore yuan lost some ground and dropped to a near three-week low at 6.5555 on Wednesday after credit rating agency Moody’s downgraded its outlook on Chinese sovereign debt to “negative”, mainly due to China’s weakening fiscal strength amid rising leverage across the economy.

But the downgrade has not triggered another round of wild devaluation speculation yet.

ING said in a report that the exchange rate policy had soothed depreciation expectations sufficiently “to free their hands for more aggressive monetary easing, which the economy manifestly needs”.

Governor Zhou reiterated last Friday during the G20 meetings that there would be more policy easing to come but that the PBOC does not intend to let the currency depreciate sharply.

Additional RRR cuts have been expected and needed for a while to offset sizeable capital outflows fanned by yuan depreciation since last October’s RRR cut, ING said. “We estimate non-foreign direct investment capital outflows stayed high at around US$160 billion in each of December and January,” the report said.

yu.xie@scmp.com

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