Analysts predict that China’s reserve requirement ratio (RRR) is about to be slashed by 50bps. How will the injection of liquidity affect bank lending and what do the cuts mean for the larger economy?
The RRR cut that the markets anticipated at the beginning of the year never arrived. Instead, the PBoC elected to perform a series of 14 day reverse repos, which injected enough cash into the banking system to tide them over during the Lunar New Year period – a season in which demand for cash is extremely high. The repos had the same effect as if 50bps had been lopped off banks’ RRR. The repos matured in the first week of February and the cash has since been returned to the PBoC’s vaults.
“The January inflation figure may explain the cautiousness of the central bank in controlling the pace of monetary easing in recent weeks, including the delay in RRR cuts and window guidance on bank lending activity. However, the slowdown in economic growth remains the priority policy concern. We maintain our view that monetary policy will be biased toward easing this year.It is very likely that the central bank will cut RRR by 50bps in February,” says an analyst at J.P. Morgan.
However, with GDP and inflation expected to head south in 2012, China market watchers believe the government will be forced to loosen monetary policy over the next twelve months. The wind is already blowing in the wrong direction as far as Chinese bank lending is concerned. In January, a total of RMB 738.1 billion ($117.3 billion) in new loans was issued. It is a figure well below the target of RMB 1 trillion the government set itself. Over the year, the government has set a target of RMB 8 trillion in new local-currency bank loans.
All of which has added to expectations that a cut to the RRR – last seen in November 2011 – is imminent. J.P. Morgan analysts also note that as exports dry up and banks diversify their short-term investment products, the RRR will have to move lower to reflect this. “RRR cuts serve to increase money supply through the multiplier effects of bank lending. With deposit growth unlikely to accelerate, further RRR cuts will be needed to maintain stable economic growth. Other policy loosening measures might emerge in the form of tax reforms and a targeted spending boost in priority areas.”
Moreover, the PBoC said China's broad money supply rose 12.4% at the end of January from a year earlier, a figure that fell short of the market’s expectations of 13.6%. It has set a target of 14% growth in the broad M2 money supply in 2012. Add to this the on-going structural reforms that are taking place in the economy as the government acts to deflate property bubbles, and support for SMEs, service industries and environmental protection will support China’s growth fundamentals in the long run.