The 8.5% meltdown last night in China’s Shanghai Composite Index, coming on the heels of an already bloody week was clearly exacerbated by the failure of the Chinese economic leadership to support markets through a cut in the banking system’s Reserve Requirement Ratio, as widely rumored and hoped, over the weekend.
While there is a solid argument for not rushing with what may seem like flailing policy measures to support every market downdraft, the failure to cut the RRR over the weekend surprised even some mid-ranking Chinese economic officials given that it is an option that has already been widely discussed and which was put on the table at the Beidaihe retreat earlier this month if needed as a support measure for the real economy (see SGH 8/12/15, “China: A Market Managed Devaluation”).
*** From what we understand, the major reason Premier Li Keqiang and the People’s Bank of China did not lower the RRR on Sunday was due to concerns it could fuel weakness and further destabilize the currency, on top of collapsing equity markets, given the Chinese Renminbi was already trading under a good deal of pressure overnight. ***
*** We believe an RRR cut is indeed very much still on the table, despite the decision not to cut last night, and furthermore is possible even if markets (and the currency) show some tentative signs of stabilization given all the damage that has already occurred. It is worth remembering the leadership also continues to target and expect China’s growth numbers to stabilize and pick up above the H1 levels in the third quarter. ***
Currency Concerns and a Military Parade
The PBoC is sensitive to pressure on the RMB as manifested not just through a widening spread between the offshore and regulated onshore RMB, or Yuan rates (the CNH and CNY), but also in how closely the onshore CNY settles to its daily central parity rate within the allowed plus or minus 2% trading band.
That keen sensitivity to the control and stability of the currency rate is certainly also a reflection the leadership is cognizant of the potential “own goal” they may have created in fueling volatility in markets with the shock decision August 11 to loosen the currency, and in effect to accept if not condone a weaker exchange rate. The last thing they wish is to exacerbate already volatile markets.
Furthermore senior Chinese officials are aware that in the current situation it is both extremely difficult and perhaps not even desirable to support the markets constantly and that, even then, it may take more than a 50 basis point RRR cut to have a significant impact at this point.
That concern over using ammunition wisely is all the more acute in light of the observed failure yesterday of the most powerful agencies to stem panic selling even with 90 billion CNY thrown at the markets after 2:00 pm.
But we nevertheless expect the State Council to take additional measures to support the RMB as well as the stock market, including an RRR cut even if it does add pressure to the currency.
Rightly or wrongly, Premier Li has been coming under criticism in political circles for replaying the turmoil in markets of last June, when Li’s delay in cutting the RRR has been blamed for leading to the stock market plunging the most at the time in seven years.
But the situation is even more dire now than in June, and with the blow to confidence, there is no question the government must do more to restore investor confidence.
Curiously the Party leadership is also looking at the market turmoil with an eye on September 3, a national holiday established by President Xi to commemorate China’s victory over Japan in World War II. President Xi has made it a top priority for the central government to ensure the success of the September 3 parade at Tiananmen Square.
Although Xi and the CFLG have no specific plan of their own to keep the RMB exchange rate and stock market relatively stable, it is almost certain Premier Li and the state council will be pressed to take forceful measures to prevent a continued stock market crash through the celebration, and to ensure RMB exchange rate stability in the near future.