Unbearable weight on monetary policy

Expectation that reserve requirement ratio (RRR) cuts can stimulate economic growth places too much importance not only on the role of RRR cut in generating credit growth, but also on the role monetary policy can play.

First, credit growth has not been the key constraint to the real economy. While the government continues to call for the financial sector to "increase support to the real economy", the continued rapid increase in overall leverage - as measured by the credit/gross domestic product ratio - is testament to the incredibly strong support the financial sector has already provided and continues to provide to the real economy.

Second, financing problems faced by some corporates are mainly structural. Small and medium enterprises (SMEs) and private companies often face financing difficulties, not because general monetary condition is not easy enough, but because their access to credit is often crowded out by State-owned enterprises (SOEs), local government investment platforms, and property related projects. The latter either have easier access to cheaper credit or have soft budget constraints and are therefore less sensitive to higher credit costs, or can use land/property as collateral to tap into the shadow financing market. Addressing SME and private sector financing difficulties require structural reforms and, in the short-term, targeted credit easing, while a whole-sale monetary and credit easing will be less effective and may exacerbate the structural imbalance.

Third, the biggest problem facing the corporate sector is not the lack of credit but the lack of investment intention or access. Of course, every business would always like to have cheaper and easier access to credit at any given time, so senior leaders may get a misleading assessment by asking businesses the questions of financing. For many companies, the bigger problem now is excess capacity, especially in heavy industry and construction related sectors. For these companies that face excess capacity, low profit margins and weak future prospect, cheaper and easier credit can help them survive better but will unlikely stimulate further investment, nor should the government want to. For many other companies especially those in the private sector and services industries, entrance barrier is the key issue, which requires faster reforms to breakdown such barriers.

This is not to say that monetary policy has no role to play in the current environment. It can help to stabilize credit growth and anchor expectations so as to create a stable macro environment for structural and fiscal policies to work. In this regard, in addition to the targeted liquidity easing, the government can cut RRR for the purpose of reducing distortions, cut benchmark interest rates (which most credit is still priced of) to help reduce the cost of borrowing, and engage in counter-cyclical macro prudential management (for example by increasing loan quota and relax loan-to-deposit ratio management).

Fundamentally, however, the problems in the real economy is not caused by too little credit, monetary and credit policies have already been heavily relied on and have diminishing effectiveness, and the government is already dealing with the aftermath of the recent credit boom along with the deep-rooted structural issues. It is time for structural reforms and restructuring of the real economy to carry bigger weights instead of monetary policy.