RRR cut confirms China policy shift as growth risks rise Premium

Move should support near-term growth, though concern about longer-term risks remains

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  • The announcement of the first cut to the reserve requirement ratio (RRR) since October underscores the shift in the government’s focus to supporting growth. Current economic risks – including concerns on financial system defaults – necessitate moves to restore growth to the industrial sector.
  • We do not think, however, this marks a wholesale embrace of easier monetary policy. The government is wary of exacerbating outstanding economic imbalances and has repeatedly said it is focusing on longer-term reforms.
  • Continued uncertainty, however, over how it precisely plans to proceed on these reforms may limit the duration of any improvement in sentiment from the cut.

Monday’s announcement of a 50bp RRR cut, coupled with dovish comments from central bank governor Zhou Xiaochuan, confirms our view that the government is now providing support to the traditional drivers of the economy because slowing consumer activity leaves it with no choice.

The decision to institute a system-wide RRR cut – even after the People’s Bank of China (PBoC) reportedly took action to rein in some banks following a surge in lending activity at the start of 2016 – suggests the government has recalibrated its focus to concentrate on short-term growth, at the expense of longer-term commitments to deleveraging and rebalancing. Unlike its market operations, which are regular and targeted, the rare announcement of a system-wide RRR cut carries an important message about policy intentions.

The cut – bringing the RRR down to 17% for large institutions – will inject around Rmb600bn ($91.5bn) into the banking system. By way of comparison, foreign exchange reserves fell $99.5bn in January, while the PBoC has provided a net Rmb780bn so far in 2016 via open market operations (OMO) (see chart).

Unlike OMO, funding from an RRR cut has no maturity period, though at least some of this financing will serve to counter capital outflows due to concerns about renminbi depreciation. Even taking this action in the first place highlights growing government confidence that it can manage the exchange rate and capital outflows: As recently as January, a leaked report of a meeting between the central bank and commercial banks revealed that senior monetary officials had cited depreciation risk as a reason not to cut the RRR.

As risks mount, the government changes tack

The PBoC’s new monetary policy stance is now officially “prudent, with a slight easing bias” – its first loosening since the global financial crisis. In a rare press conference on Friday, Mr Zhou played down concerns about overall debt levels and also highlighted the relatively low level of mortgage debt as a percentage of overall bank lending (only 10% vs 40-50% in many countries, he said).

These marked shifts in official rhetoric follow record lending activity in January – including loans to households – while our banking industry sources say February activity was of comparable intensity. As well as pumping record amounts of funding into the system via OMO and other funding channels, the government has tweaked its housing policy for homebuyers outside of the biggest cities to make it easier to purchase. The PBoC announcement also comes on the heels of a pledge on February 16 by all of the main economic agencies to provide liquidity support to stabilise industry.

This shift to focus on short-term growth makes sense given fresh evidence that Chinese consumer activity remained at historically low levels at the start of the year (see chart).

The government may also be taking action to create a benign liquidity environment in order to forestall default risk. At the very least, the RRR cut means a continued bond market rally (see chart). Investors have been ignoring rising default concerns amid a benign liquidity environment, and this is set to continue, potentially encouraging financial institutions to increase leverage further.

No wholesale embrace of monetary policy easing

However, we do not think this marks a wholesale embrace of policy easing at the expense of tackling longer-term economic imbalances. The government’s official position, from day one, was to avoid the knee-jerk resort to easing of which its predecessors were guilty.

Nonetheless, the monetary authority is now clearly attempting to support near-term growth. Balancing this goal against that of resolving longer-term imbalances is a potentially dangerous challenge, and the government has still not fully articulated how it intends to achieve reform without effecting the very economic hard landing and financial system crisis it is committed to avoiding.

FT Confidential Research is an independent research service from the Financial Times, providing in-depth analysis of and statistical insight into China and Southeast Asia. Our team of researchers in these key markets combine findings from our proprietary surveys with on-the-ground research to provide predictive analysis for investors.

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