Chinese Central Bank to Cut Required Reserve Ratio for First Time in 2023, Observers Say Short-term Interest Rate Cuts Now Unlikely


The People’s Bank of China (PBOC) has announced plans to implement the first cut to the required reserve ratio (RRR) in 2023, as part of efforts to shore up liquidity in the Chinese financial system.

On 17 March, PBOC announced that it would reduce the RRR for Chinese financial institutions by 0.25 percentage points on March 27, for the purposes of “efficiency gains and rational quantitative growth in the economy; effectively combining macro-economic policies, improving the level of servicing the real economy, and maintaining rational and sufficient liquidity in the banking system.”

Following the cut, the weighted average RRR for Chinese financial institutions will stand at approximately 7.6%. The move will not include financial institutions that are currently subject to a 5% RRR.

Wang Qing (王青), chief macro-analyst at Golden Credit Rating, said that the current cut is nonetheless a comprehensive cut that is estimated to inject 500 billion to 530 billion yuan in long-term funds into the Chinese banking system, saving banks 5.6 billion to 6 billion yuan in funding costs on a per annum basis.

“This RRR cut sends a signal of monetary stabilisation, which will help stabilize market expectations and provide a favourable monetary and financial environment for the promotion of economic recovery,” Wang said.

“Since the start of the year, the supply and demand of the credit market have been booming, driving new credit growth in the first two months of 2023.

“The implementation of this RRR cut will directly support bank credit extension in liquidity terms, in order satisfy the credit demand of business entities.

“We expect the extension of the trend of large-scale year-on-year (YoY) increases in credit extension in March, of which enterprise loans will continue to be the mainstay.

“As the property market gradually stabilizes and household consumption rapidly rebounds, household loans are also expected to rebound.”

Wen Bin (温彬), chief economist at China Minsheng Bank, said that in the first two months of the year China’s key economic indicators had displayed a positive trend, but the foundations for economic stabilisation were not yet solid.

“The timely adoption of RRR cuts will release long-term liquidity into the financial system, which will help reduce the capital cost of banking institutions and guide financial institutions to further increase their support for the real economy,” Wen said.

Li Qilin (李奇霖), chief economist of Hongta Securities, said that the move by PBOC had taken market observers by surprise.

“Following improvements to financial and economic data in the first two months of this year, the central bank has combined increases in outstanding medium-term lending facilities (MLF) with a cut to the RRR. This move is beyond market expectations.”

Li said there are several reasons for the adoption of more concerted measures by PBOC.

“Firstly, pressure on economic growth is still present. Secondly, at present movement of capital in the interbank market has risen, and the volatility of interest rates has intensified. Thirdly, there is structural pressure on interbank market liquidity.

“In order to achieve a certain degree of sustainability in credit growth and reduce the volatility of credit provision, it is necessary to make up for the liquidity gap through RRR cuts.”

Wen Bin highlighted the role of RRR cuts in reducing the real cost of funds for financial institutions.

“While MLF issuance has continued to increase in recent months, their price are relatively high, which is not conducive to reducing financing costs,” Wen said.

“In the current circumstances, where the debt costs of the banking sector are creating pressure and net interest margins continues to narrow to a historically low level, the central bank’s timely reduction of the RRR will help to better stimulate the financing demand of market entities, stabilize the economy, reduce costs, effectively alleviate debt and operational pressure for banks, and enhance the stability of their operations and risk-resistance capability.”

A cut to the RRR diminishes the likelihood of PBOC reducing short-term interest rates in future.

“The implementation of the RRR cut does not mean that monetary policy will be adjusted towards a looser direction, and the possibility of cuts to policy interest rates (rates on open market instruments) in the short term is not likely,” Wen said.

“As a key policy tool for counter-cyclical adjustment, interest rate cuts often play the role of ‘delivering charcoal in the snow.’ Irrespective of China’s previous monetary policy operations or the monetary policy practices of other countries, it is rare to implement interest rate cuts to help the economy move faster once the economy has entered the recovery process.

“Consequently, against a background of the momentum in economic recovery that was established in the first quarter, the necessity of reducing the policy rates is not high.”

“Constrained by factors such as the renminbi exchange rate and uncertainty surrounding interest rate hikes in other major economies, as well as the current positive economic condition, stable public expectations, and stronger confidence in development, the need and urgency to cut interest rates in the short-term is not high,” said Pang Ming (庞溟), chief economist and director of research department of Jones Lang LaSalle, Greater China.