The People’s Bank of China (PBOC) joined six of the world’s leading central banks recently to help shore up liquidity and restore confidence in markets battered all year from Europe’s debt crisis.
China’s new cash reserve ratio went into effect on Dec 5 with some analysts speculating another cut before the Chinese New Year.
The PBOC cut the reserve requirement ratio (RRR) for banks by 50 basis points – the first such cut since December 2008.
The RRR for large banks fell from 21.5 percent to 21 percent, freeing up around 390 billion yuan (about $61 billion) in funds for the banks to lend, according to calculations by The Wall Street Journal.
As China goes about reorienting its growth model from being export-driven (and with a large current account surplus) to domestic demand-focused, the attempt at monetary easing should encourage credit growth and help reinvigorate the economy, analysts say.
China’s move came as the US Federal Reserve, along with five other leading central banks, reduced the cost of borrowing US dollars by 50 basis points.
China’s top leaders have been hinting for several weeks that policy will be fine-tuned to support growth. But up until now, China has resorted to targeted easing to prop up small manufacturers under stress without loosening overall monetary policy.
Dong Tao, head of non-Japan economics with Credit Suisse, said he saw the cut as “monetary policy fine-tuning.” In his assessment, the move will release about 396 billion yuan of liquidity into the banking system.
“The move is essentially aimed at helping smaller financial institutions whose liquidity conditions have been tighter vis-à-vis the larger banks,” he wrote in a note.
“We think the move was part of a co-ordinated intervention by global central banks to address the tight liquidity conditions worldwide, although China seems to have chosen not to officially join the global action and announced the RRR cut separately,” he said.
“The sharp fall in the A-share market and a weak PMI number may have helped firm up the government’s decision to cut as well,” he said.
The purchasing manager index (PMI) for November was down 1.4 percentage points to 49, compared to 50.4 in the previous month. This is the first time the headline PMI fell below the 50 mark since February 2009.
Tao said he expects the PBOC may cut the RRR one more time to 20.5 percent but added, “I do not think this action is the start of a reversal of the official prudent monetary policy stance.”
Yu Song of Gao Hua Securities said the fact the PBOC cut the RRR “shows the government wishes to send a clear signal to the market that they are loosening policy.”
“Going forward, I expect continued policy loosening as exports slow and inflation moderates,” Yu said in a note.
The cut in the RRR “is a clear signal that Beijing has decided that the balance of risks now lies with growth, rather than inflation,” wrote Stephen Green, regional head of research in Greater China for Standard Chartered, in a note.
Green said he expects China will reduce the reserve ratio again in January due to a potential liquidity crunch coming up before the Chinese New Year.
In recent months, capital flows into China have slowed amid general unease over the global economy, worries about China’s slowing growth and reduced expectations for appreciation of the yuan.
In October, China recorded its first monthly outflow of foreign currency since 2007.
RBS analyst Li Cui said the RRR cut had been widely expected by the market as part of the government’s “targeted loosening.”
“In recent months inflows from foreign trade and investment have slowed,” Li said. “In response the PBOC injected liquidity through open market operations to maintain steady base money growth, prompting expectations for possible RRR cuts. This is a cautious shift towards easing in a constrained monetary policy space,”
Meanwhile, China’s banks have been reporting strong results so far this year.
The Bank of China results for the first three quarters of 2011 showed a profit after tax of 101.28 billion yuan up 22.09 percent over the same period last year.
Of all the Chinese banks, the Bank of China is said to have the biggest exposure to Europe.
The Industrial and Commercial Bank of China reported after tax profit for the nine months ending Sept 30 of 164 billion yuan up 28.31 percent over the same period last year.
While the banks have reported solid results so far this year, the results are not reflected in the share prices which have been less than spectacular.
The International Monetary Fund (IMF) in a report last month said China’s banks are strong enough to resist a one-off shock, such as a plunge in property prices or a jump in exchange rates, but not necessarily strong enough to cope with several shocks coming at the same time.
The report, part of a review of the world’s 25 major financial sectors, said China’s recent progress in creating a “properly functioning financial system” has helped the economy weather the global economic crisis.
“As the world’s second largest economy continues to grow, the demand for credit is growing rapidly, exacerbated by rising asset prices, including housing. As a result, credit is increasingly being sought from outside the formal banking system as the government tries to manage the flow of bank credit,” the IMF said.
In its first assessment of the health of China’s financial system under the Financial Sector Assessment Program, the IMF said the risks are manageable, and can be addressed by reforms that upgrade the country’s capacity to respond to crises while supporting strong domestic demand.
“China’s banks and financial sector are healthy, but there are vulnerable elements that need to be addressed by the government, and experience in other countries has demonstrated the sooner these are addressed, the better,” said Jonathan Fiechter, deputy director of the IMF’s Monetary and Capital Markets Department and the head of the IMF team that conducted the assessment.
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