Explainer: Is China set to cut RRR soon? What are the implications?

On March 30, 2016, a clerk counts Chinese 100 yuan banknotes in a counting machine at a commercial bank branch in Beijing, China. REUTERS/File Photo/Kim Kyung-Hoon (Reuters) – BEIJING, July 8 (Reuters) – The Chinese government committed on Wednesday to use timely reductions in the amount of cash banks must maintain as reserves to boost the slowing economy, bolstering hopes for a policy shift soon. The cabinet stated that such decreases in the reserve requirement ratio (RRR) will assist underpin the economy, particularly small businesses, surprising investors who had expected a steady tightening of policy. The People’s Bank of China (PBOC) has been gradually reducing pandemic-driven stimulus to reduce debt risks while retaining targeted support for small businesses. An RRR cut would be the first since the COVID-19 pandemic shook the economy in April 2020. IS THERE GOING TO BE AN RRR CUT? It’s possible, but not certain. The PBOC normally follows the cabinet’s instructions, which governs the world’s second-largest economy and sets China’s policy direction. The PBOC has generally followed the cabinet’s calls for RRR decreases in the past, but not always. After the cabinet signaled a cut in June 2020, for example, there was no policy change. China’s economy is weakening, with growth expected to drop to 7-8 percent in April-June from a record 18.3 percent in the first quarter, which was substantially skewed by the rebound effect after the severe drop in activity in early 2020. Because of growing commodity prices, the current slowdown may worsen. Small businesses in downstream industries may face the burden of growing raw material costs as they try to pass on higher expenses to customers. WHEN AND HOW DO YOU DO IT? I’m not sure. Given the cabinet’s emphasis on supporting small businesses, most experts predict a targeted RRR drop for small banks, although a cut for all lenders cannot be ruled out. Nomura analysts predict a 50-basis-point drop across the board in the coming weeks. If consumer inflation softens in the next months, Wen Bin, an economist at Mingsheng Bank, predicts a cut by the end of September. A reduction in the RRR could bring long-term money into the banking system, allowing banks to increase their loan books and reduce their financing costs. Other policy mechanisms, such as the medium-term lending facility (MLF), will provide short- to medium-term financing. In recent years, the PBOC has used MLF loans more frequently than RRR decreases. In the second half of this year, expected RRR decreases will assist to relieve liquidity pressures generated by the maturity of over 4 trillion yuan ($617.2 billion) in MLF loans and net government bond issuance totaling 4.5 trillion yuan. HOW MUCH ROOM DO YOU HAVE FOR MORE CUTTING? There is still space, but it is not as large as it once was. The RRR drop in April 2020 was the eighth since the PBOC began an easing cycle in early 2018, which increased dramatically after the COVID-19 outbreak paralyzed economic activity in early 2020. The PBOC reported in May 2020 that the average RRR for Chinese financial institutions has dropped by 520 basis points from early 2018 to 9.4%. DO YOU THINK AN RRR CUT WILL CHANGE POLICY? The central bank has been attempting to slow credit growth in order to reduce debt and financial risks, and that policy is unlikely to change. Because the economic recovery is not yet broad-based and balanced, Chinese policymakers have committed to avoid abrupt policy changes. For the past 14 months, the PBOC has kept its benchmark lending rate, the loan prime rate (LPR), constant. The economy is largely forecast to expand by more than 8% this year, compared to the government’s modest growth objective of over 6%, indicating that there is no pressure to accelerate easing. Local governments are anticipated to increase bond issuance to channel more funding into essential projects, which will assist to support GDP. An predicted RRR drop, combined with efforts to lower market interest rates, will almost certainly be a policy fine-tuning operation to relieve negative economic pressure. Beijing should also decrease market interest rates, according to a former central bank official, to stimulate economic growth and relieve funding demands on local governments. ($1 = 6.4808 Chinese yuan renminbi renminbi renminbi renminbi renminbi renminbi Kevin Yao contributed to this report.
Shri Navaratnam edited the piece.
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