China’s relaxation of interest-rate controls has left cutting banks’ required reserves as the chief monetary tool to counter a slowdown, focusing attention on an option used in the past decade only during financial crises.
Premier Li Keqiang’s insistence that China won’t implement more-powerful stimulus than faster spending on railways and reserve-ratio cuts for rural banks has failed to sway almost half of surveyed economists, who predict the central bank will lower the ratio nationwide this year. The tool unleashes about $80 billion of liquidity into the banking system for every half percentage-point reduction.
China has put its interest-rate system in flux with last year’s removal of limits on borrowing costs and a shift toward interbank market rates. That’s left officials reliant on the command-economy tool of the reserve ratio if they need to call on monetary policy to support growth even as they seek to give markets a greater role and rein in surging debt.
“The changing monetary-policy regime means the reserve ratio has a more material impact because it impacts liquidity in the interbank market,” said Yao Wei, China economist at Societe Generale SA in Hong Kong, who forecasts a half-point cut this quarter. “That changes the interest rates that actually matter.”
China last lowered reserve ratios during the depths of the European debt turmoil, when three cuts were made from November 2011 to May 2012, having previously used the tool in 2008 during the global financial crisis. Reductions also have coincided with periods when capital has flowed out of China, according to Michael Pettis, a finance professor at Peking University in Beijing.
The nation had a first-quarter surplus of $118.3 billion in the capital and financial account, according to preliminary government data released today, close to the fourth quarter’s $127 billion. China has had an estimated $178.4 billion in capital inflows over the past 12 months, compared with $27.3 billion in the previous 12 months, based on data compiled by Bloomberg.
The government has used increases in the ratio as an “industrial-sized vacuum cleaner” to soak up liquidity when the nation faced a balance-of-payments surplus or was buying dollars to prevent the yuan from appreciating, said David Loevinger, former U.S. Treasury Department senior coordinator for China affairs and now an analyst at TCW Group Inc. in Los Angeles. The ratio, now 20 percent for the largest banks, is one of the world’s highest, he said.
Chinese authorities are transitioning from a system of state-directed credit to one where markets play a “decisive” role in pricing capital. A floor was removed from lending rates in July and People’s Bank of China Governor Zhou Xiaochuan said in March that deposit rates will be liberalized in one to two years.
Goldman Sachs Group Inc. analysts in November designated the seven-day repurchase rate as their key barometer, replacing the central bank’s one-year lending rate. The PBOC has increasingly used tools including repurchase agreements to manage liquidity in the financial system and influence interbank rates, which remain more volatile than benchmarks in other economies such as the U.S.
“The PBOC is struggling to find a new framework for monetary policy and what’s the best rate to target,” said Shen Minggao, head of China research at Citigroup Inc. in Hong Kong. “There is too much volatility right now in these rates.”
Policy makers will prefer to cut the reserve ratio over interest rates because reducing the ratio can have the dual impact of releasing money into the financial system and influencing expectations, said Xu Gao, chief economist at Everbright Securities Co. in Beijing.
“Because of interest-rate liberalization, the interest-rate cut will take place purely through the expectation channel,” said Xu, who formerly worked at the World Bank.
Xu is among 10 of 26 analysts in a Bloomberg News survey conducted from April 16 to April 23 who said they expect a reserve-ratio cut this quarter. Twelve out of 25 see a reduction by the end of the year.
The State Council, or cabinet, this month outlined a package of spending on railways and housing and tax relief to support growth. The central bank this week lowered the reserve-requirement ratio for some rural banks by as much as 2 percentage points.
Australia & New Zealand Banking Group Ltd. estimated the rural-bank move will unlock as much as 100 billion yuan ($16 billion), while a nationwide reserve-ratio cut of a half point would release about 500 billion yuan.
Reducing the ratio to 19 percent would leave about 9.25 trillion yuan locked up as reserves at China’s four largest banks, based on government data showing they had almost 48.7 trillion yuan of local-currency deposits as of March, or 45 percent of the system-wide total.
Stronger stimulus isn’t being considered and growth that’s a bit higher or lower than 7.5 percent can be deemed to be in a reasonable range, Premier Li said last week, according to a government statement. China will ensure the 2014 expansion target can be reached through reform and changes to the structure of the economy, Li said.
“2014 has always been about this knife edge that they are on: trying to implement these reforms and yet protect the downside of growth,” said Tim Condon, head of Asia research at ING Groep NV in Singapore, who formerly worked at the World Bank.
While economists at UBS AG and JPMorgan Chase & Co. said the rural ratio cut may lower the odds of a broader reduction, Nomura Holdings Inc. and Standard Chartered Plc are among those predicting more drastic action after property construction plunged in the first quarter and money-supply expansion weakened. The world’s second-largest economy is forecast to grow 7.3 percent this year, the slowest pace since 1990, based on the median estimate in a Bloomberg survey.
“They will cut when they have to do it -- if the economy continues to slow and all other targeted easing doesn’t work,” said Citigroup’s Shen, who didn’t participate in the reserve-ratio survey. “When everybody knows the economy is bad, what else can they do?”