China-U.S. Chamber of Commerce, By Chris Gallagher Apr 17, 2014 2:52 AM ET
A string of weak first-quarter economic data has provoked many China economists to predict Beijing will loosen monetary policy to keep growth on track, specifically by reducing banks' reserve requirements.
But dealers in China's money market aren't betting on it yet.
The divide in opinion highlights the risk that foreign investors, who have begun moving money into Chinese equities recently, may not get the liquidity support they need to drive a rally in China's long-underperforming equities markets in 2014.
But if the sceptics are right, it would mark a continuation of a strategy launched in 2013, during which the People's Bank of China relied almost entirely on short-term liquidity tools to keep the economic engine ticking over while retaining the ability to crack down on sloppy lending at short notice.
"The PBOC's signals have traders here firmly convinced that an RRR cut is not coming, at least not in the second quarter of this year," said a dealer at an Asian bank in Shanghai.
"The new government that came into power one year ago appears determined to carry with its plans to adjust China's economic structure with less investment and asset bubbles."
Traders also noted that similar predictions about imminent cuts in the reserve requirement ratio (RRR) circulated in the markets during the same time in 2013 after an uninspiring first quarter, but those never materialised, and the PBOC went on to dramatically tighten money instead in June.
Beijing has been giving mixed messages this year as well. On the one hand, leaders have committed to keeping liquidity adequate to support growth. But at the same time they have signalled they are ready to start letting indebted firms in overcapacity industries default on bonds and go bankrupt.
"Companies complaining they are short of money are either liquidity intensive companies, such as property firms, or those which rely on borrowing new money to roll over old debt," the Financial News, a newspaper run by the PBOC, said in a commentary in late March.
"If the PBOC release money via an RRR cut now, liquidity will flow to such companies. As a result, property prices will continue rising and overcapacity in sunset sectors will worsen."
The argument for further loosening this year is simple: China's exports have slid, manufacturing growth appears stagnant, and at the same time credit and money creation has slowed.
"We believe that economic momentum may have stalled temporarily in March," wrote Nomura economist Zhang Zhiwei in a research noted dated April 10.
"If growth slows again in May, which is our baseline case, the government may loosen policy further, particularly on the monetary side."
Analysts have noted that the central bank has allowed benchmark short-term rates to sink back below 4 percent since February, implying regulatory relaxation after a tough 2013.
Indeed, benchmark rates remained low this week, with the weighted average of the benchmark seven-day repo staying at a comfortable 2.74 percent on Thursday, its lowest level since mid-March. Traders believe any rate below 4 percent indicates relatively accommodative liquidity conditions.
On Wednesday, the PBOC relaxed the reserve requirement ratios at rural banks, an economically insignificant move.
But some believe that Beijing will do more. The next, more drastic step would be to unleash the hundreds of billions of yuan currently trapped in Chinese banks by Beijing's mandatory reserve requirements, some economists say.
TOO MUCH OF A GOOD THING
A typical RRR cut by the PBOC is usually 50 basis points, but a single cut would pump about 550 billion yuan ($89 billion) base money into China's monetary base.
If one applies a four-time money multiplier effect to that injection, it would add 2.2 trillion yuan in fresh cash in circulation in the banking system.
But enduring weak demand within China, together with a huge existing 116 trillion yuan in broad M2 money supply, means that a further injection would likely flow into industries full of firms struggling to stay afloat such as property and steel, prolonging industrial overcapacity.
"A base money injection via an RRR cut at the present market conditions will do nothing to help the economy but will push up prices of speculative assets," said a senior trader at a Chinese state-owned bank in Shanghai.
"The PBOC has far from exhausting handy tools, so it will first resume reverse repos in open market operations, supplemented by other similar tools such as re-lending, re-discount and SLFs (short-term lending facilities) before it will resort to RRR or rate cuts." ($1=6.2 Yuan)