China: RR Cut and the RMB

Published on February 29, 2016

Premier Li Keqiang presided over a meeting at his office this morning (Beijing time: February 29) with Vice Premier Ma Kai, PBoC Governor Zhou Xiaochuan, and Finance Minister Lou Jiwei.

At that meeting, Zhou and Lou briefed the Premier on the G20 meeting and the account given by the Chinese officials to their international counterparts (see SGH 1/22/16, “China: G-20 Meeting, Volatility, Growth, and FX”). Zhou then proposed the PBoC announce a 50 basis points cut in the Reserve Requirement Ratio (RRR) that night, and Premier Li signed off on it, strategically timed for just ahead of the upcoming Fourth Session of the 12th National People’s Congress (NPC) that starts on March 5.

*** Chinese officials clearly hope today’s RRR cut will give the money markets positive support. But as they expect China’s economic growth rate to come in at around a 6.6-6.7% GDP level in Q1, some senior officials believe there is a very high chance they will cut the RRR by another 50 basis points again in April, possibly around April 10. If the economic situation, especially industrial activity, continues to decelerate, the PBoC could even also cut interest rates by 25 bps in April. ***

*** Chinese officials are well aware that lowering the RRR could fuel further RMB depreciation. Indeed, Premier Li and the senior policymakers now expect a “modest depreciation” of the RMB against the dollar in March. But as long as the RMB is within their tolerance level – for now from what we understand stronger than around 6.6000 RMB/dollar — they believe the PBoC will be able to intervene less frequently in the FX market. But Beijing, they warn, is committed to intervene if necessary to stop the RMB value from falling “too sharply” in the offshore market in the near term. ***

The Outlook and More Liquidity

At the Monday morning meeting with Premier Li and Vice Premier Ma, Governor Zhou proposed that the PBoC announce on Monday night it will lower the Reserve Requirement Ratio (RRR) by half a percentage point. The intention was to swiftly follow through on his “prudent with an easing bias” monetary policy comments made before the G20 meeting, and to respond to local governments’ expectations and hopes for more easing that had been on hold since the Chinese New Year.

Premier Li agreed, and signed off on the 50 basis point RRR cut now in order to have it in place ahead of the upcoming Fourth Session of the 12th National People’s Congress (NPC) session starting March 5. At this session, Li is said to be expecting more supportive actions for the first year of the 13th Five-Year Plan to be endorsed.

Today’s RRR cut, in conjunction with some measures on the fiscal side, is aimed at boosting real economic growth. A universal RRR cut of 50 bps is expected to release about 700 billion yuan into the money markets.

Chinese officials nevertheless reiterate that today’s action does not mean they are concerned China’s economy is facing a hard landing. They maintain that after cutting the RRR they will continue to pump money into the markets through reverse repos, the Standing Lending Facility (SLF), Medium-term Lending Facility (MLF), and matured central bank bills through March.

Indeed the PBoC will continue pushing down borrowing costs until they see solid signs the economy is finally gaining momentum.

Larger Fiscal Stimulus Planned

These monetary policy moves are now coming on top of the additional fiscal stimulus the Chinese policymakers are intending to pursue in order to hit their growth targets for this year (see SGH 1/5/16, “China: More on RMB and Stimulus Policies”).

Finance Minister Lou has already said that China is considering an increase in its budget deficit to 3 percent of GDP in 2016 from 2.3 percent in 2015 (official numbers – real spending is estimated to have been a point or so above that). China could further raise the target ratio to 4 percent of GDP or even higher from 2017 to 2020, if needed, to offset the impact of reduced fiscal revenue and to support broader reform.

China’s relatively small outstanding debt, rational structure, continued growth in fiscal revenue, and solid assets of state owned enterprises are among the factors cited as supportive of the country’s efforts to raise its deficit ratio to GDP.

That said, Chinese officials expect the Q1 economic data will not necessarily provide all that much room for optimism. But they remain confident the second quarter this year will show the desired signs that stimulus measures are kicking in.

The expectation is that the economy will then start to tick back upward in the second half of the year.

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