China's central bank announced on Monday that it will lower its reserve requirement ratio (RRR) for commercial banks by 0.5 percentage point, effective Tuesday.
The cut is to "ensure reasonably ample liquidity in the financial system; guide a stable and appropriate growth in credit; and create a favorable financial environment for supply-side structural reform," according to a statement of the People's Bank of China (PBOC).
The RRR cut came two days after the closing of the G20 Finance Ministers and Central Bank Governors Meeting in Shanghai, when China's central bank described its monetary policies as "prudent with a slight easing bias," a shift away from the simple "prudent" of recent years.
The reduction will inject 700 billion yuan (107 billion U.S. dollars) into the financial system, and is expected to shore up the stock market, said Luo Yi, chief analyst with Huatai Securities.
As around 930 billion yuan injected recently through open market operations comes due this week, so the market will face a short-term liquidity squeeze, which the RRR cut will ease, said Guan Qingyou, an analyst with Minsheng Securities.
Monday's cut was the first RRR reduction since October last year, when the central bank also lowered interest rates to reduce firms' borrowing cost.
Since October, the PBOC has used more frequent open market operations and liquidity facilities such as the standing lending facility and medium-term lending facility.
Such reliance on money market tools signals a moving away from blunt instruments like RRR, which makes Monday's decision something of a surprise, said Bloomberg economists Tom Orlik and Fielding Chen in a research note.
Still, the RRR cut is a more cost efficient way of providing liquidity than open market operations, and will prompt banks to lend more and support the real economy, said Zeng Gang of the Chinese Academy of Social Sciences.
To arrest the economic downturn resulting from the transition to a more sustainable growth model, China has cut interest rates or the RRR fives times in the last year. Zhu Haibin, J.P. Morgan China's chief economist, predicted a more "accommodating" monetary policy in 2016, with one 25 basis points interest rate cut and four 50 basis points RRR cuts this year.
Besides monetary easing tools, officials also signaled more fiscal expansion including raising the fiscal debt ratio and have pinned their hopes on supply-side structural reform.
