Debate swirls on reserve ratio requirement

There's heated debate in China about whether the government will cut banks' required reserve ratio, which has been steady for 22 months.

If history is any guide, the central bank would have acted already.

Credit growth is weak, the property market appears to be headed toward a correction, and industrial activity is sluggish, all of which points to a stimulus. But the People's Bank of China hasn't moved.

Wu Xiaolian, a former PBOC deputy governor, spoke recently against a cut, saying that such a move would have a "substantial impact on the market".

PBOC Governor Zhou Xiaochuan said last weekend that the economy does not need a "large-scale stimulus".

Stephen Green, a China economist with Standard Chartered Plc, said that the governor might view a reserve ratio cut as such a move.

Banks' current reserves at the PBOC total 21 trillion yuan ($3.4 trillion), so cutting the ratio by 0.5 percentage point would free up about 1 trillion yuan.

By comparison, total social financing-the broadest measure of credit in China, which takes in many sources of funding beyond banks-was 1.55 trillion yuan in April.

The PBOC's stance is in line with a comment by President Xi Jinping, who said China's economic situation has entered into a "new normal". A major feature of the "new normal" is deleveraging. High leverage has built up over the past few years amid easy credit, while real economic growth has grown much less responsive to monetary stimulus.

As the global financial crisis deepened from September 2008 onward, the PBOC cut the reserve ratio by a total of 2.5 percentage points.

But current conditions are more like those in 2011, featuring slowdowns in industrial activity and housing. In 2011, the PBOC cut the reserve ratio by a total of 1 percentage point.

There's a wide range of views on the issue now.

Green wrote in a report on May 21 that while deleveraging cannot be achieved with super-loose monetary policy, it also cannot be attained with high real interest rates and low nominal GDP growth.

"We believe the time is coming when a RRR cut and broader-based easing will be needed to stabilize growth," he wrote. "You cannot deleverage an economy that is not growing."

And growth is definitely slowing. The economy expanded at its slowest pace in 18 months in the first quarter. The 7.4 percent rate was below the 7.5 percent full-year target mentioned by Premier Li Keqiang.

Things didn't improve much in April. SouFun Holdings Ltd, which operates a property portal, said housing prices declined month-on-month in 45 of 100 cities, up from 37 cities in March. Its sample of 25 major cities showed a sales plunge of 17.8 percent year-on-year in April.

On the macroeconomic front, the consumer price index was up 1.8 percent year-on-year in April, down from 2.4 percent in March. The producer price index fell 2 percent in April.

The HSBC Flash China Manufacturing Purchasing Managers Index recovered to 49.7 in May from April's final reading of 48.1, beating a Reuters poll forecast of 48.1. But it remained below the level of 50, which separates growth from contraction, indicating that manufacturers experienced a slight drop in business.

Shen Jianguang, chief economist with Mizuho Securities Co Ltd, said via microblog on Monday that a reserve ratio cut would be the best macroeconomic means to avoid a hard landing.

Lu Zhengwei, chief economist at Industrial Bank Co Ltd, said much the same thing via Weibo, stating that a reserve ratio cut would help lower medium-to long-term funding costs, which would boost growth.

Li gave a speech on May 22 during a visit to Chifeng, Inner Mongolia. He said that "the economy faces downside risks and we should take it seriously" and "fine-tune policies appropriately".

China's central bank governor said the country is facing unusually intricate economic circumstances at present, which pose new challenges to the bank's monetary policy.

Zhou made the remark during a seminar held in east China's Zhejiang Province, a region with thriving private lending, according to an online note released by the bank on Tuesday.

China is trying to manage multiple tasks simultaneously amid increasing downward pressure, including stable economic growth, structural adjustment, reform, risk control and people's well-being.

This represents fresh challenges to the world's second-largest economy, which is striving to ensure stability and improve services in the financial sector with a prudent monetary policy, Zhou said.

He asked all branches of the PBOC to follow current monetary policy and help create a sound environment to support the local economy and facilitate national reform.

Improving financial supervision and pushing forward an inclusive financial system were also mentioned in the note.

Zhang Zhiwei, a Hong Kong-based China economist with Nomura Securities Co Ltd, said Li's comments were a signal that easing might speed up. "We believe this statement is stronger than his statements in previous speeches ... It reinforces our view that fiscal and monetary policies will be loosened in Q2 to stabilize growth and counter the macro risks from the property market," Zhang wrote in report on Tuesday.

The Goldman Sachs Group Inc said on Tuesday that easing will most likely take the form of higher credit quotas and more active open market operations from the PBOC. An RRR cut is unlikely because it sends a "high-profile" easing signal, it added.