RRR cuts to ease liquidity conditions

New steps likely to prevent slowdown in base money growth

The decision of the People's Bank of China to cut reserve requirement ratios for lenders by 50 basis points will help mitigate liquidity risks and prevent a slowdown in base money growth amid increased capital outflows, leading economists said on Thursday.

Wang Tao, chief China economist at Swiss bank UBS AG, estimated that China's net capital outflows exceeded $160 billion in the fourth quarter of last year, accounting for more than half of the total outflows in 2014, as the US dollar continued to strengthen in recent months.

"The People's Bank of China's recent but limited use of medium-term lending facilities was not sufficient to offset such a huge drain on domestic liquidity. In addition, liquidity demand is set to spike as the Lunar New Year approaches, alongside anticipated new initial public offering subscriptions, which will further strain interbank liquidity conditions," she said.

China's capital and financial account posted a deficit of $91.2 billion in the fourth quarter, according to figures released by the State Administration of Foreign Exchange on Tuesday.

Ma Jun, chief economist of the PBOC's research bureau, said: "As the central bank has withdrawn from regular intervention in the foreign exchange market, the yuan funds outstanding for foreign exchange are no longer a major channel of injecting long-term liquidity into the financial system. Under such circumstances, it is necessary to cut the RRR, along with the application of other monetary policy tools, to maintain reasonable growth of broad money supply and adequate liquidity to ensure a steady increase of credit and total social financing."

Deepening economic slowdown and disinflationary pressure are also among the reasons cited by economists for the RRR cut.

The manufacturing Purchasing Managers Index, a key measure of factory activity, fell to 49.8 in January, hitting a low last seen in September 2012, according to the National Bureau of Statistics. The decline in PMI has increased market expectations for further monetary policy easing.

Zhu Haibin, chief China economist at JPMorgan Chase & Co, estimated that the universal and targeted RRR cuts could inject liquidity of 650 billion yuan into the financial system.

Like many other economists, he said he believes that the move is the precursor of a series of monetary easing measures.

"In the near term, we expect the PBOC to increase the magnitude of reverse repo operations before the Lunar New Year to meet the seasonal high liquidity demand. We also expect one more rate cut of 25 bps in the first quarter and a second universal RRR cut of 50 bps in the second quarter, supplemented by targeted measures and targeted RRR cuts to facilitate economic restructuring," he said.

Ding Shuang, senior China economist at Citigroup Inc in Hong Kong, said the RRR cut does not represent a deviation from the generally prudent monetary policy stance, but the market will most likely interpret it as a stimulus measure.

"We expect two or three additional RRR cuts this year amid continued capital outflows, just to enable broad money to grow by 12-13 percent," he said.