China Cuts Bank Reserve Requirement – First Time in 3 Years

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Dec. 1 – The People’s Bank of China (PBC) will lower the reserve requirement ratio (RRR) at China’s financial institutions by 0.5 percent starting on December 5, a move that marks the first RRR cut in three years.

The 0.5 percent drop will bring the RRR at large-scale financial institutions to the level of 21 percent, and reduce the RRR at small and medium-scale financial institutions to the level of 17.5 percent. A total of over RMB396 billion in liquid capital will therefore be unlocked.

Under high inflationary pressure, China lifted the RRR 12 times last year, bringing the bank reserve requirement to an exceptionally high level of 21.5 percent and money supply growth to a noticeably low level.

The tightened liquidity has largely restrained bank loan offers, therefore putting many of China’s small and medium-sized enterprises (SMEs) into financial troubles.

The challenges presently facing SMEs are even more severe than the ones in 2008, when the Global Financial Crisis broke out, says in a report recently submitted by All-China Federation of Industry and Commerce to the State Council.

The RRR cut comes at a time when concerns over a looming economic slowdown in the country grow. The October’s flash purchasing managers’ index compiled by the HSBC reached a 32-month low, revealing shrinkage in both industrial output and new orders from the struggling Western economies.

The relieved inflationary pressure since October has also given Beijing more motivation to go for a “fine-tuning” of its monetary policies. The increase in China’s consumer price index (CPI) declined to 5.5 percent in October, after staying above 6 percent for four consecutive months. Experts predict that CPI growth will decline further in November to around 4.5 percent.

In addition, concerns over excess liquidity have been reduced due to a diminishing amount of foreign “hot money” inflow to China. According to PBC statistics, China’s funds outstanding for foreign exchange at the end of October declined for the first time since December 2007, showing a slower increase in the country’s forex reserves. Analysts believe the decrease in the central bank’s forex purchases is partly related to tempered enthusiasm for speculative investment into China, backed by widespread speculation of RMB depreciation.

While the newest RRR cut does not appear to be a surprise to most investors, economists emphasize it does not mean a directional change in China’s monetary policy.

Guo Tianyong, professor at China’s Central University of Finance and Economics, says China should stick to a prudent monetary policy stance and that the RRR decline has only been implemented to hedge against the currently over-tightened liquidity.

Xu Xiaonian, professor at China Europe International Business School, worries the Central Bank’s attempt to allow more liquidity will bring back high inflation. In a recent tweet, Xu indicated that structural reform – rather than the simple use of the RRR tool – is the real remedy for China’s economic problems.

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