The Chinese central bank’s abrupt decision to cut the required reserve ratio for commercial lenders has triggered concerns that the liquidity unleashed could fuel further gains in asset prices.
On 17 April the People’s Bank of China made the surprise announcement that it would be reducing the required reserve ratio for large-scale commercial banks, joint-stock commercial banks, municipal commercial banks, non-county rural village commercial banks and foreign-invested banks by 100 basis points starting from 25 April.
The reduction is expected to unleash 1.3 trillion yuan in liquidity, of which 900 billion yuan will be used to repay the medium-term lending facilities (MLF) borrowed by lenders from PBOC as part of the latter’s open market operations.
The sudden release of such a sizeable volume of liquidity has triggered concerns within China that funds will eventually flow into the real estate or stock markets, particularly given the contribution made by ample liquidity to asset prices during the period from 2014 to 2017.
According to a research paper from Changjiang Securities entitled “A Historical Perspective on Market Trends Following Targeted Reserve Ratio Reductions (历史看，定向降准后的市场走势情况) the Chinese central bank has implemented a total of 8 required reserve ratio cuts since 2014, three of which were targeted (April 2017, June 2014 and June 2015), and five across the board (February 2015, April 2015, September 2015, October 2015 and March 2016).
The paper concludes that the Shanghai Composite Index and Shenzhen ChiNext Index showed a high probability of short-term gains in the wake of across the board reserve ratio cuts, although there was no pattern of price shifts following targeted reductions.
Liu Deng (刘澄), a professor at the Beijing Science and Technology University’s School of Business, said to China Economic Weekly that the required reserve ratio cut is only a “micro-adjustment,” and does not mark a shift in PBOC monetary policy towards greater loosening.
He expects the China Banking and Insurance Regulatory Commission (CBIRC) and PBOC to implement strict controls of the specific usage of funds by lenders, in order to ensure that liquidity flows towards enterprises.
In order to prevent the released funds from flowing into the real estate sector, PBOC has outlined clear restrictions on the usage of funds, requiring that financial institutions direct them towards lending for small and micro-enterprises.
PBOC has required that commercial lenders make appropriate reductions in financing costs for small businesses and improve financial services for them, as well as included these requirements in its macro-prudential assessments (MPA).
For this reason Deng does not expect the reserve ratio cut to have much direct impact upon China’s stock markets.
“However, this also sends the signal that the state wants economic stability, and hopes to reduce downward pressure on the economy,” said Deng. “For the stock market, this can also be viewed as a positive.”
Gu Yunchang (顾云昌), vice-chair of the Ministry of Housing and Urban-Rural Development’s specialist commission and chair of the National Real Estate Commercial League (全国房地产商会联盟), said that that the cuts are unlikely to spur gains in property prices in first or second-tier cities, given that the Chinese central bank’s determination to channel the funds towards small businesses in the real economy.
“The core of this reserve ratio cut is expanding support to the real economy,and small and micro-enterprises in particular,” said Gu.