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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

The central bank's monetary policy closely follows the designs of the Central Government in creating a "mini-stimulus" for the economy through targeted RRR cuts. However, the measure implies that the central bank also thinks there is not enough liquidity in the market, at least in some sectors. The key requirement for targeted RRR cuts to work is that liquidity reaches the agricultural sector and small and micro-sized enterprises, thus improving the credit structure. The policy remains experimental and as yet unproved.

Adapting to the economy

Sheng Songcheng, Director of the Statistics and Analysis Department of the PBC, said the reason the central bank did not introduce an "across-the-board" RRR cut is that the conditions in China are not fit for such a measure.

According to figures from the National Bureau of Statistics, China's economic growth has been slowing down since the fourth quarter of 2010. In the first quarter this year, China's GDP grew by 7.4 percent, the lowest in the last 18 years. This is also lower than the target of 7.5 percent set by the Central Government for the whole year. Market investors have therefore speculated that the central bank will soon relax monetary policy in order to prevent the further slowdown of economic growth.

However, the central bank thinks that although Chinese economic growth has declined, the 7.4-percent growth registered in the first quarter is still acceptable, and the employment rate remains steady. As opposed to the situation in the same period last year, when the interbank borrowing rate soared and commercial banks faced a cash crunch, currently the interbank borrowing rate remains low, newly increased funds outstanding for foreign exchange is not decreasing remarkably and market liquidity is still ample. For these reasons, the PBC will continue to implement a sound monetary policy and keep liquidity at a reasonable volume so as to maintain steady economic performance.

Sheng said when it comes to the matter of ensuring economic growth, people should not focus solely on monetary policy. The effect of monetary policy in stimulating economic growth is limited, and there will be serious side effects to quantitative easing. For the purposes of long-term growth, such "quick-fix measures" are no replacement for comprehensive reform.

Liu Yuhui, a professor with the Chinese Academy of Social Sciences, said China needs an appropriate monetary policy to guard against risks of economic slowdown, but at present, it is not appropriate to adopt a policy of monetary easing.

According to Liu, having experienced the cash crunch last year, the market had anticipated monetary policy easing, but the central bank is determined to keep market liquidity steady. The Chinese economy has been engaged in deleveraging since 2010, but the process has been very slow because overall economic growth and corporate profitability have both dropped. Chinese companies are highly reliant on debt financing and their leverage ratio is high, leaving little space for the central bank to engage in further monetary easing.

Liu said the central bank should be prudent when it considers cutting RRR and interest rates. Since the beginning of this year, the money market interest rate has been declining slowly, indicating that market liquidity is no longer so tight. Since the central bank cannot control the flow of funds if the monetary easing is introduced, the liquidity released would likely flow to industries with serious bubbles or high debt rates instead of stimulating growth of the real economy. While economic growth is weak, asset bubbles may push up inflation rates.

RRR and interest rate cuts may not even significantly boost the economy, because China has now fully liberalized its lending rates, and rapid development of bank wealth management products and Internet financing have also weakened the central bank's control of its deposit interest rate. Therefore, adjusting the PBC's interest rates would not necessarily affect their counterparts in the real economy.

Moreover, China's interbank market does not lack money now, so cutting the RRR may not boost the real economy as it has in the past.

According to Liu, even if the monetary policy were not to be significantly eased, money supply looks unlikely to fall short this year.

Email us at: lanxinzhen@bjreview.com

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