As promised by Premier Li Keqiang late last month (and as expected by market participants) China announced an RRR cut on Wednesday, in a bid to further bolster the economy and address seasonal liquidity needs.
The PBoC said it would cut banks’ reserve requirement ratio by 50bps, effective January 6.
The last broad RRR reduction came in September. It was accompanied by the announcement of two staggered, targeted cuts which were implemented in October and November.
The economy is expected to slow further in 2020, despite a (possibly temporary) thawing in the Cold War with Donald Trump.
Recently, China’s economic data has improved, with the latest signs of stabilization coming from the official PMIs, out earlier this week. The NBS manufacturing gauge has printed in expansion territory for two consecutive months. Imports recently moved back into positive territory after six months in contraction, industrial profits inflected sharply for the better after October’s plunge and industrial output and retail sales rebounded in November as well, adding to the upbeat narrative.
China has also delivered a series of 5bps cuts to the revamped loan prime rate. The PBoC cut the MLF rate (off which LPR is priced) in November. Three weeks later, LPR dropped by a commensurate 5bps, marking the third time the de facto benchmark was cut since the calculation was tweaked over the summer. The PBoC also cut the 7-day repo rate in November for the first time since 2015, and lowered the 14-day rate to match in December during a series of liquidity injections.
On Sunday, the PBoC said financial institutions will cease to use the benchmark lending rate as a reference for pricing credit starting this month, shifting instead to the revamped LPR. Over the course of the six months from March to August 2020, existing loans will be converted to the new base as well.
The three LPR cuts mentioned above have pushed the one-year tenor 20bps lower than the old one-year lending benchmark, which means the conversion of the loan stock amounts to more easing.
The latest RRR cut will presumably help allay fears of a liquidity shortage ahead of the Lunar New Year holidays.
The move will release some 800 billion yuan, 120 billion of which will benefit small and medium-sized banks, the PBoC said Wednesday, emphasizing that they should lend to small businesses. Annual funding costs for banks will be 15 billion yuan lower after the move, which is also aimed at reducing margin pressure from the mandated repricing of the loan stock to the LPR.
“Rising cash demand for the Lunar New Year holiday and a flood of special bond issuance by local governments is likely to tighten cash conditions in January, and could prompt the central bank to free up funds banks must hold as reserves”, Reuters wrote last week, in a pretty decent summary of a note from Guotai Junan. “The Lunar New Year, which falls on January 25 next year, is expected to boost short-term demand for cash by about 1.5 trillion yuan [while] banks’ demand for cash for special bonds is also expected to peak in late January, bringing the total liquidity gap to as much as 2.8 trillion yuan”.
You can be absolutely sure that more RRR cuts and LPR reductions are in the cards. Defaults are rising and worries about cascading credit events are heightened by a ridiculous system of cross-holdings and overlapping guarantees.
Beijing has pledged to avoid any type of destabilizing panic, but efforts to allow the market to play a greater role in sorting things out will invariably come as something of a shock. Authorities have even shown a willingness to test the waters on SOE restructurings.