7 May 2014
Why the PBOC has to cut the RRR
We think a general RRR cut needs to happen as soon as possible. An RRR cut is
not only a short-term measure against an economic slowdown and high financing
costs, but also the appropriate monetary policy tool to use at this time.
China has become dependent on quantity-based monetary policy tools such as
RRR and loan expansion targets, in our view. For a long time these tools have
been useful due to: 1) inflexibility in the exchange rate; and 2) a lack of financial
system marketization. Along with the government consensus on the importance of
marketization in economic reform, and the market distortion from quantity-based
tools, we believe it is time for the policy focus to shift to price-based tools.
There are four reasons for an RRR cut: 1) interest rate liberalization has taken off,
Positive
news
and price-based tools allow more efficient resource allocation in the market; 2)
current market distortion due to onerous banking sector control; 3) the current
RRR, at 20%, is above its optimal level as a policy tool; and 4) China’s RRR is
much higher than global standards.
General RRR cut as the next policy focus
Since the rural RRR cut was announced in the second round of mini-stimulus (see The
second wave of mini stimulus 7 April), we have observed that the possibility of a general
RRR cut has become the subject of much heated debate in the market, with strong opinions
from both supporters and opponents.
In summary, supporters of a general RRR cut hold the view that: 1) China’s economic growth
is losing momentum; 2) there is limited inflationary pressure in 2014; and 3) high long-term
interest rates have added to the corporate sectors’ business costs. Opponents believe that: 1)
the employment market remains generally stable; 2) the signal sent to the market by an RRR
cut is too strong; and 3) strong growth of the FX purchase position, at CNY200b in March,
has reduced the need for an RRR cut.
Jianguang Shen
jianguang.shen@hk.mizuho-sc.com
+852 2685 2022
Michael Luk
michael.luk@hk.mizuho-sc.com
+852 2685 2155
In our view, an RRR cut is not only necessary, but it should be done as soon as possible.
This is not only a short-term measure against economic slowdown and high financing costs,
but also the appropriate monetary policy tool to use at this time. We believe China’s
economic growth has deteriorated in 2Q, as evident from the data so far (see More bad news
about weakening economic momentum 5 May). Among the three expenditure components of
GDP, investment and exports are both losing speed, while it is unlikely that consumption will
generate sufficient growth (see China’s slowdown worse than expected 28 April).
Time for price-based policy tools to take the stage
Following the steps previously taken by the government to liberalize China’s interest rates,
we believe the time is right for the PBoC’s monetary policy focus to shift to price-based
(interest rate) monetary policy tools, from quantity-based tools. The current quantity-based
restrictions, such as the high RRR, administration controls on loan growth, and loan-todeposit ratio (LDR), have already put monetary conditions under tight control, after more
than three decades of quantity-based tools.
In our view, the dependence on quantity-based tools has given rise to the current policy
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Economics Update
gridlock. For example, the PBoC announced 38 changes in the RRR between July 2006 and
May 2012. These included 18 hikes between July 2006 and June 2008 that shifted the RRR
to 17.5% from 7.5%. These were accompanied by only eight interest rate hikes. During the
financial crisis, the PBoC cut both the RRR and interest rates four times, along with
administrative measures to promote loan extensions. In the normalization process that
followed between January 2010 and July 2011, the PBoC raised the RRR 12 times, taking
the RRR for larger financial institutions to its peak at 21.5%. Meanwhile, interest rates were
cut five times.
Why do China’s policymakers rely so much on quantity-based tools? We think it is because
of the lack of exchange rate flexibility. In order to keep the RMB stable, the government has
to accumulate massive foreign reserves. As of March 2014, China’s foreign reserves have
reached USD3.95t, increasing by around USD40b per year in the last seven years.
Low levels of financial marketization have made quantity-based monetary tools necessary.
The decisions to produce and lend in China’s economy are often affected by the
government’s administrative controls, such that state-owned lenders and borrowers often
lack interest-rate sensitivity. Quantity-based tools, as a result, have been much more
effective in monetary policy implementation.
In particular, the PBoC had been biased towards using open market operations (OMO) to
manage the liquidity supply directly. However, as the supply of central bank bills increased,
the cost of OMO execution also increased. In comparison, the cost of RRR adjustment is
even lower. Therefore, RRR adjustment has become the main monetary tool.
We believe quantity-based tools have been effective measures in China due to these
historical reasons. However, as China’s financial market reform advances, and the negative
consequences from these tools continue to surface, we believe the time has come for pricebased tools to take the stage.
Four reasons to support an RRR cut
1)
Interest rate liberalization has taken off
Interest rate liberalization has taken off. Price-based tools allow more efficient resource
allocation in the market. Since the Third Plenary Session, the government has reached a
consensus on the importance of marketization in economic reform. The money market
interest rates and bank lending rates have already been liberalized. Although the ceiling for
deposit rates continues to exist, the interest rate for large deposits has already been
liberalized, as has the corporate entrusted deposit rate.
In addition to this, the banking sector’s off-balance-sheet wealth management products and
internet money market funds have made free-floating interest rate products widely available.
The time has come for the cost of capital to be determined by market demand and supply. If
monetary conditions continue to be controlled through administrative measures and quantitybased tools through a high RRR, the market’s allocation mechanism will be distorted, to the
detriment of the economy.
2) Shadow banking partly caused by onerous banking sector control
The RRR for large financial institutions is as high as 20%. The reserve only receives 1.62%
interest from the central bank. The cost to the banking sector, according to our estimates,
would be close to a 2% tax. In addition to the 75% LDR, 5% business tax and the challenges
from interest rate liberalization, the competitiveness of the traditional banking sector has
been hurt by the government, in our view.
3) The current RRR at 20% is higher than optimal
Zhang Xiaohui, director of the PBoC’s monetary policy department argued that there is an
optimal RRR level as a liquidity management and monetary policy tool. The optimal level is
based on: 1) the spread between lending and deposit rate; and 2) interest rates on the RRR.
2
Economics Update
We found that at 20%, the current level is already much higher than the optimal level, which
would lead to reduced effectiveness. 1
4) China’s RRR is too high by global standards
The RRR in the Eurozone, UK, Mexico, Poland, and Hungary is below 5%, while the US and
Japan have adopted progressive RRRs. In Japan, only deposits above JPY2.5t are liable to
the highest of four RRR requirements, which is 1.2%. In the US, deposits below USD8.5m
are not subjected to RRR, while 3% applies to deposits between USD8.5m-USD45.8m. Only
the deposits at the highest tier, above USD45.8m, are subjected to a 10% RRR requirement.
In our view, the PBoC will have to reduce its quantity-based control, especially the RRR. In
addition to providing support to the market, optimizing the interest rate structure, and
reducing the liquidity pressure in the economy, an RRR cut can also reduce the restrictions
on credit supply, and return some room to maneuver for price-based monetary policy tools.
In addition, we believe the 75% loan-to-deposit ratio should be removed. Although this may
not be practical in the short-term due to regulations on commercial banking, we believe the
ratio should expand the eligibility requirement for deposits, and extend the assessment
period.
All in, we believe monetary policy should ease as the economy faces downward pressure
amid limited inflationary pressure. The government should shift the monetary policy focus
back to price-based tools through RRR cuts and reduced LDR assessment requirements.
This could kill two birds with one stone, serving the dual purpose of supporting growth while
promoting reform, in our view.
Fig 1 Official PMI rebound in March and April are weaker than normal
54
53
52
51
50
49
48
47
46
Apr-12
Oct-12
Apr-13
PMI
Oct-13
Apr-14
HSBC PMI
Source: CEIC, Mizuho research
1
, where
The optimal RRR could be found by
is the optimal RRR,
is the lending
rate， is the deposit rate and ， is the interest rate for required reserve. “中国的准备金、准备金税和
货币控制：1984-2007” Zhang Xiaohui et al, Economic Research, 2008 (7)
3
Economics Update
Fig 2 Our LKQ index supports slower economic growth in 1Q
LKQ index
14
12
10
YoY %
8
6
4
2
0
-2
-4
Mar-11
Sep-11
Mar-12
Sep-12
Mar-13
Sep-13
Mar-14
Source: CEIC, Mizuho research
Fig 3 Power generation growth may hit new low in April
50
25
40
20
15
20
10
10
5
0
YoY%
YoY%
30
0
-10
-5
-20
-30
Oct-11
Apr-12
Oct-12
Coal consumption for pow er
Apr-13
Oct-13
-10
Apr-14
Pow er generation (RHS)
Source: CEIC, Mizuho research
Fig 4 Risk in property sector is rising
45
80
40
60
30
40
25
20
20
15
0
10
-20
5
0
Mar-09
-40
Mar-10
Mar-11
Property investment
Source: CEIC, Mizuho research
4
Mar-12
Mar-13
Floor space started (RHS)
Mar-14
YoY% YTD
YoY% YTD
35
Economics Update
Fig 5 We believe price-based policy tools should be used to neutralize FX influx
Position for FX purchase
800
700
600
500
CNYb
400
300
200
100
0
-100
-200
Mar-08
Mar-09
Mar-10
Mar-11
Mar-12
Mar-13
Mar-14
Source: CEIC, Mizuho research
Fig 6 High borrowing cost hurts the real economy
Governm ent bond
5.5
5.0
4.5
%
4.0
3.5
3.0
2.5
2.0
Jan-13
Mar-13
May-13
Jul-13
1-mth
10-yr
Sep-13
Nov-13
1-yr
3-mth
Jan-14
Mar-14
May-14
Source: CEIC, Mizuho research
Fig 7 RRR is above optimal level at 20%
%
Required reserve ratio
22
21
20
19
18
17
16
15
14
13
12
Apr-08
Apr-09
Apr-10
Large financial institutions
Source: CEIC, Mizuho research
5
Apr-11
Apr-12
Apr-13
Small and medium-sized financial institutions
Apr-14
Economics Update
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Economics Update
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