By Zhang Ming
China recently decided to cut the reserve requirement ratio (RRR) by 100 basis points, which will take effect on Monday. This is the fourth time this year the People's Bank of China (PBC), the central bank, has lowered the RRR. The RRR for small to medium-sized and large depository financial institutions will have dropped to 12.5 percent and 14.5 percent, respectively. The move is expected to pump another 750 billion yuan ($108 billion) into the market.
One reason for this adjustment is to lower the financing costs for small and medium-sized enterprises (SMEs) to support the development of the real economy. Another is to better structure the liquidity in commercial banks and financial institutions.
The latest RRR cut is based on the current economic situation. There has been a slowdown in growth and the GDP growth rate is expected to fall to 6.6 percent in the third quarter this year and 6.4 percent in the fourth quarter. The US-China trade row is likely to continue weakening the export sector's contribution to GDP growth and this will impact manufacturing investment. The curbs on excessive growth in the real estate industry will lead to a gradual reduction in investment. The special bonds local governments are allowed to issue will only mildly spur the increase of investment in infrastructure.
The difficulty SMEs face in raising funds is the reason for the RRR cut at the financial level. The previous RRR cuts were also intended to channel more liquidity to SMEs, but commercial banks are inclined to cut support for SMEs amid the current tightened financial regulation and stricter supervision of non-standard debt assets.
So in the past few months, the growth rate of aggregated financing for the real economy has been lower than the growth of yuan-denominated loans, and M2 growth has outrun that of M1. This indicates that it is getting harder for SMEs to raise funds. Cutting the RRR alone cannot solve this problem. Other supporting measures and a more vigorous equity market are also needed
The RRR cut also reflects a belief that inflation will not be a major threat in the short term. Some recent events have pointed to a possible increase in inflation, including a rise in oil prices, the flood in Shouguang in East China's Shandong Province, the outbreak of African swine fever, the US-China trade row and the rise in rents in first-tier cities. But these are mainly supply-side shocks without much demand-side influence, so their impact on inflation will not last. The Consumer Price Index (CPI) may rise to 2.5 percent in the near future, but it is unlikely to rise by much more. And though there are concerns about the inflation threat from rebounding food prices, this will be far down the road.
The PBC has stressed that the RRR cut will not put depreciation pressure on the yuan. In fact, as the US Federal Reserve continues to raise interest rates, the PBC's attitude shows that it is determined to maintain the yuan-to-dollar exchange rate at a certain level, and it is putting domestic policy goals above external goals. The resumption of counter-cyclical factors in August has reinforced the PBC's ability to control the central parity rate. The measures to constrain capital outflows have been strengthened. Plus, the PBC still maintains certain controls on FX reserves and the offshore market. Therefore, the chance of the yuan weakening beyond 7 to the dollar is slim.
Another supporting condition for the PBC to push through the RRR cut is that the real estate industry has been brought under control. Housing prices in third- and fourth-tier cities have fallen due to curbs on shantytown redevelopment. Tightened controls on bank loans have also cooled the housing market in second-tier cities and the trade volume for properties in the first-tier market has been lukewarm. Property taxes on houses also affect the expectations of the market. As long as the real estate regulations do not loosen up, the RRR cut will not reheat the housing market.
After this RRR cut, it is unlikely the PBC will cut the rate again before the beginning of next year.
The author is chief economist at Ping An Securities and a research fellow at the Institute of World Economics and Politics under the Chinese Academy of Social Sciences. firstname.lastname@example.org