Why China’s latest bank reserve ratio cut comes with strings attached
The central bank is trying to walk a fine monetary line to encourage growth and wind back debt, analysts say
China’s latest move to boost lending to the economy’s weakest links highlights the tightrope the central bank is walking to both shore up growth and cut leverage, according to analysts.
On the eve of the week-long National Day holiday, the People’s Bank of China (PBOC) announced that it would cut the amount of cash banks had to hold in reserve, providing the lenders channelled funds to certain types of clients.
While a cut in the reserve requirement ratio – the share of a commercial bank’s deposits that it must put aside at the central bank as liquid reserves – is not new, it was the first time the PBOC had put conditions on such easing.
The central bank said that from next year lenders could have a 0.5 percentage point cut in the ratio if its lending to small businesses and rural borrowers accounted for more than 1.5 per cent of new loans in 2017. A 1.5 percentage point cut was on offer if such loans accounted for 10 per cent of a bank’s total lending for the year.
With three months to go until the cuts come in, banks have an incentive to boost lending to small borrowers now.
And since most banks will meet the conditions for the first cut, the PBOC’s decision will in theory free up 800 billion yuan (US$120 billion) in funds, based on China’s 160 trillion yuan in outstanding deposits as of the end of August.
The central bank’s decision is a departure from the traditional monetary policy moves of an interest-rate cut or a broad reserve ratio reduction.
Analysts said the conditional cut and repeated denials of a blanket policy easing showed the PBOC had less room to manoeuvre around the US Federal Reserve’s interest rate rises and China’s slowdown in growth.
Larry Hu, chief China economist at Macquarie Securities in Hong Kong, said the PBOC had been held hostage to the market’s view that a broad reserve ratio cut equated to loosening, making the central bank reluctant to use the tool.
Hu said there were good reasons for China to cut the reserve ratio, which stands at about 16 per cent for most banks and is much higher than in developed economies.
One of those reasons was a higher ratio encouraged shadow banking and distorted the financial system, he said.
But Commerzbank chief emerging markets economist Zhou Hao said it was unnecessary and unrealistic for the PBOC to change monetary tack now.
“Why should China start monetary loosening when economic growth stands well above the target and the United States is on a cycle of interest rate hikes?” he said.
The Fed has expected to raise rates at least five times in the next two years to eventually reach 2.75 per cent, closing the gap with China and luring more capital back to the US.
Fears about capital outflows are still fresh in China – they sent the yuan to a five-year low against the US dollar last year and forced Beijing to impose strict capital controls.
Nevertheless, Zhou said, market liquidity was influenced more by risk appetite and was not as tight as many thought.
Bank of Communications analyst Chen Ji said the conditional ratio cut was just a “structural adjustment to channel more capital into the real economy and maintain the overall stability of market rates and liquidity”.
The central bank has said it will continue to chart a prudent and neutral monetary policy course, vowing to maintain stable liquidity with various tools and guide “reasonable growth” of credit and aggregate financing.
Beijing has tried to avoid another round of “money printing”, with M2, the broad measure of money supply, growing at a record low rate of 8.9 per cent by the end of August.
In the past, most funds slushing around the system have been used to speculate on the property or capital markets, further inflating asset prices and squeezing funding for the real economy.
Chen said the central bank had stabilised interbank rates in the past quarter and was set to guide market expectations about medium-term liquidity.
Hu said China’s monetary policy tone could only change if there was a sharp economic slowdown, prompting the authorities renew loosening to meet growth targets.
He said economic growth could slow to 6 per cent next year and another round of policy loosening could be rolled out from the second half of 2018.
“But it will depend on the new leadership’s bottom line for growth,” he said.