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UPDATED: August 6, 2014 NO. 26 JUNE 26, 2014
No Easy Options
Targeted reduction of the reserve requirement ratio does not indicate China is loosening its monetary policy
By Lan Xinzhen

MORE MONEY: A staff member of a bus company in Handan, Hebei Province counts banknotes. China has steadily increased the money supply in the market (HAO QUNYING)

The People's Bank of China (PBC), the country's central bank, on June 16 cut the reserve requirement ratio (RRR) by 0.5 percentage points for commercial banks that have met relevant requirements and reached stipulated ratios in their agro loans and lending to small and micro-sized enterprises. This is the second time in the last two months that the PBC has reduced the RRR for targeted financial institutions.

According to the PBC, for institutions to be eligible, their ratio of new agro loans to total new loans had to be more than 50 percent in the last year and the rate of agro loan outstanding to total loan outstanding had to be more than 30 percent at the end of last year. Alternatively, banks could qualify if the ratio of new loans to small and micro-sized enterprises to total new loans was more than 50 percent in the last year and the ratio of small and micro-sized enterprise loan outstanding to total loan outstanding had been more than 30 percent at the end of last year.

Based on these standards, the current round of targeted reduction covers about two thirds of the country's city commercial banks, 80 percent of rural commercial banks that are not incorporated at the county level, and 90 percent of rural cooperative banks that are not incorporated at the county level.

Targeted reduction of RRR has been interpreted by market observers as a sign that China will ease its monetary policy. China's stock prices also rose after the news broke. A country may ease its monetary policy in three ways: increasing loans, cutting interest rates and overall RRR cuts. The recent two targeted RRR cuts are considered by some to be a trial for an overall cut.

However, the central bank denied this surmise. The PBC said that this round of targeted RRR cuts is designed to encourage financial institutions to allocate more funds to the areas in the real sector that need financial support, and to make sure monetary policy is transmitted more smoothly to the real economy. At present, liquidity is generally sufficient and the stance of monetary policy has remained unchanged. The PBC has thus announced it will maintain its current course.

Will it work?

Guo Tianyong, Director of the Center for Chinese Banking Studies of the Central University of Finance and Economics, said that this time, the central bank didn't specify which banks qualify for RRR cuts, but instead set out the required ratios for agro loans and lending to small and micro-sized enterprises. Compared with the previous round of RRR cuts, this round covers many more financial institutions. It is estimated that the recent RRR cut will provide a liquidity boost of than 200 billion yuan ($32.52 billion) to the market.

Guo said that against the backdrop of China's economic growth slowdown, structural adjustment has become a more important target for macro-control and will affect the sustainability of the country's development in the future. Targeted RRR cuts represent a measure of structural adjustment through inputting funds to the agricultural sector and small and micro-sized enterprises.

Rather than the risky business of lending to small and micro-sized enterprises, small commercial banks and city commercial banks prefer interbank business that carries low risks but high returns. It is not yet certain whether or not banks will really allow the released liquidity to flow to the agricultural sector and small and micro-sized enterprises.

Guan Qingyou, Deputy Director of the Research Institute of Minsheng Securities Co. Ltd., says targeted RRR cuts are designed to ensure stable economic growth, but even this measure cannot change the financial institutions' reluctance to lend. Even if financial institutions do grant credit, the money will inevitably find its way to financing platforms and the industries with excessive capacity.

Wang Yong, an analyst with CITIC Securities Co. Ltd., thinks China's top leadership is continuously making adjustments, demonstrating flexibility. In the first half of last year, it stressed that it would not attempt to stimulate economic growth, and in the second half, it pledged not to use "strong stimulus" policies. This year, it began to adopt "mini-stimulus" policies to stop the slowdown of economic growth.

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