China cuts its reserve ratio again

China's central bank announced on Saturday it would lower the reserve requirement for commercial lenders by 50 basis points, the second time it has taken such action this year to inject more market liquidity and shore up the economy.

Effective May 18, the cut would release about 400 billion yuan into the market, said Lian Ping, chief economist at the Bank of Communications Co Ltd. After the cut, the reserve requirement ratio (RRR) for major banks will stand at 20 percent, while for small and medium-sized lenders, the ratio will be reduced to 16.5 percent.

"The move reflects that the Chinese economy fell into unstable conditions and timely adjustments in monetary policies are needed," said Wu Xiaoqiu, an economist at Renmin University of China.

The world's second-largest economy continued to slow in April, as industrial production registered the lowest growth in three years of 9.3 percent. Retail sales growth slowed to 14.1 percent from March's 15.2 percent, and export growth undershot expectations by falling to 4.9 percent from 8.9 percent one month earlier.

The new cut in RRR was mainly targeted at countering capital outflows, which would pose negative effects on current monetary polices, said independent economist Andy Xie.

China's foreign-exchange reserves dropped by $4.69 billion from February to March - the first monthly decline since last December, partly dragged down by short-term capital outflows, said analysts.

Conditions are right for another RRR cut in May, said Liu Ligang, head of China economics at Australia and New Zealand Banking Group Ltd.

He said renewed political risks in the euro zone and a sharp fall in market liquidity led by a drought in maturing central bank bills called for further easing of monetary policy.

China's new yuan loans in April fell to 681.8 billion yuan, down by 61.2 billion yuan compared with a year earlier, and 328.2 billion yuan lower than March's 1.01 trillion yuan, according to data released by People's Bank of China, the central bank, on Friday.

"M2 (a broad measure of money supply that covers cash in circulation and deposits) growth in the first quarter fell short of the targeted 14 percent. This will need to be addressed by fast reserve money growth."

Liu said a reserve-ratio cut would be more effective at encouraging bank lending and accelerating M2 growth than a reduction in the intensity of open market operations.

He added the central bank might need to lower the RRR by 1.5 to 2.0 percentage points this year to meet the M2 growth target including the cut this time, and the next RRR cut could come in June or July.

Lu Zhengwei, chief economist at the Industrial Bank Co Ltd, said given the economic growth rate has been close to the lower limit of tolerance, and inflation rate eased to somewhere below normal level, in the second and third quarter the government would continue to loosen its monetary stance, "but a large dose of relaxation is impossible".

Growth of the consumer price index, a main gauge of inflation, moderated to 3.4 percent year-on-year in April in line with expectations, compared with March's 3.6 percent.

Lu said in the future the central bank would probably take more actions through open market operation and make necessary innovation to its monetary instruments.