Whether the People’s Bank of China will further cut the reserve requirement ratio (RRR) to inject liquidity to the market within the year, and how it will speed up the transition of the monetary policy framework have received much attention from the market recently. Experts interviewed by the China Securities Journal recently said that in order to prevent financial risks and the Fed’s continued steady increase in interest rates, China’s monetary policy will not change its direction in the short term. With the further advancement of interest rate liberalization, the medium-term loan facility (MLF) may not be used freely. To replace MLF with targeted RRR cut signals a further move towards the restructuring of the monetary policy framework. During the year, the central bank still has room to cut RRR.
Monetary policy could hardly change its direction
Liquidity has always been a hot spot in the market. Zhu Hongming, an associate researcher at the Institute of Finance Research of the State Council Development Research Center, said that liquidity in the future mainly depends on two aspects. One is how the yield of US Treasury bonds and the normalization of U.S. monetary policy moves; the other is the liquidity operations in domestic market. With stable economic and financial conditions, liquidity can remain basically stable.
Some experts believe that currently the liquidity in financial market appears to be relatively abundant, but there is a possibility of two much liquidity. Xu Gao, the chief economist of Everbright Securities Asset Management, said, “the current conditions are similar to 2014. At that time the growth of social financing was weak. Monetary policy was easing mainly by increasing base money. But when the base money increased, the scale of social financing did not. Then the base money could only accumulate in the financial market, and cannot promote the growth of real economy financing, which can be called the 'barrier lake' of liquidity. Currently the barrier lake may reappear. There will be a liquidity glut in the financial market, followed by a bubble of financial assets. Under this circumstance, it is very necessary that monetary policy should increase the liquidity of the real economy. Otherwise, difficulties of financing for the real economy will become more significant."
In terms of monetary policy, the People's Bank of China recently issued a report on the execution of China's monetary policy in the first quarter. The report pointed out that in the next phase, it will make innovations in ideas and methods for financial regulation, maintain the continuity and stability of policies, implement a prudent and neutral monetary policy, guide expectations, maintain reasonable and stable liquidity, and create a neutral and moderate monetary and financial environment for the supply-side structural reforms and high-quality development.
From the external environment, Xu Gao said that the U.S. economic indicators have bottomed out. In terms of economic prosperity, developed economies have begun to enter a downward trend. In this situation, how long the US can raise interest rates and reduce its balance sheet can remain doubtful. According to the current U.S.’ established path, it would raise interest rates three times this year, and raise interest rates two or three times next year. The pace is relatively moderate, and its impact on China’s monetary policy is completely controllable. China’s monetary policy has ample space to hedge external influences.
Shen Jianguang, chief economist at Mizuho Securities, said that there is no possibility of a directional change in monetary policy in the short term. The Fed still maintains a steady pace in interest rates hike, making it necessary for China’s monetary policy to maintain a neutral and tight posture. It is expected that at this crucial point when the Fed lifts interests rate this year, China’s central bank’s interest rate may still be raised.
MLF will not be used without restrictions
The MLF and the overnight standing loan facility (SLF) have played a good role as new tools in the central bank's monetary policy tools. They have enhanced the flexibility and effectiveness of central bank’s liquidity management, and maintained a reasonable and stable liquidity. However, there are some limitations of such monetary policy tools.
The People's Bank of China decided on April 17 that starting from April 25, it will cut the RRR for certain financial institutions by one percentage point. These financial institutions will use the funds released from the withdrawal to repay the MLFs they borrow from the central bank.
Zhao Qingming, chief economist from China Financial Futures Exchange (CFFE), viewed that MLF and SLF which were taken as reference over past several years are a kind of swap. But they have two obvious shortages. One is that they will raise costs of bank funds; the other one is that only some banks can gain capitals and liquidity through these two tools.
Pan Xiangdong, chief economist of New Times Securities, said that in order to guard against financial risks, the central bank had supplemented liquidity via MLF several times since the first quarter of 2016, but it could not completely replace the move of cutting RRR. First of all, MLF worsens layer of liquidity. As MLF needs pledged goods, compared with large financial institutions, the medium and small ones can’t get liquidity from the central bank easily; instead, they can only obtain liquidity from large financial institutions. As a result, one the one hand, it worsens inequity in liquidity; on the other hand, it lengthens chains of financial products. Secondly, there’s time limit for MLF and uncertainty in continuation of MLF, which will trigger market’s unstable expectation on liquidity. RRR cut adds long-term capital supply, which will help stabilize liquidity and lower costs of bank fund.
In the opinion of Shen, as an innovative tool, MLF can make up liquidity of financial institutions but has its limitation. As the important deign for the transformation of China’s monetary policy framework, MLF is a kind of tool with transitivity. Along with marketization of interest rate being further promoted, it won’t be used without limit; instead, its use may be restricted. Using RRR cut to hedge MLF is a sign of transformation of monetary policy framework.
Less necessity to maintain high RRR
Market participants thought the central bank is likely to continue to cut the RRR two or three times this year. Xu considered that solve the difficulty in financing of real economy depends on relaxing of monetary policy. Under the background with smaller scale of social financing, the central bank is likely to cut the RRR further.
The central bank may cut the RRR or replace MLF loans by cutting RRR again in July, according to Hua Changchun, chief analyst from research institute of Guotai Junan Securities. With regard to transformation of monetary policy framework and the keynote of neutral and prudent monetary policy, there might be RRR cut in the future. On the one hand, the RRR is still quite high in China, which influences the transmission of monetary policy. On the other hand, as new rules of asset management begins to be put into place, China should keep monetary and credit steady under the tight finance.
Zhu Hongming added that adjusting RRR is always one of monetary policy tools. Given consideration to current situation, required reserves are quite advantageous in releasing liquidity, capital stability and costs. Currently, China’s RRR stays very high. When choosing monetary policy tool, cutting RRR can be considered based on change of liquidity. Whether the central bank will cut RRR for some financial institutions or for all financial institutions will depend on situation of liquidity and market’s consideration on capital stability and costs.
“In terms of transformation of monetary policy framework, there’s still potential for lowering RRR.” Shen indicated that under the background that marketization of interest rate accelerates and bank profits are squeezed, higher RRR will push up costs of capitals of financial institutions. Lately, reform of China’s interest rate marketization quickens again, and many banks including state-owned large banks raised interest rates for certificates of deposits. As the gap between interest rates for deposits and loans narrows resulting from marketization of interest rate, costs of capitals of financial institutions increase and efficiency decreases as China’s RRR is higher than that of major economies like European countries, US and Japan. Therefore, there’s chance for further cut in RRR.
Shen stressed that RRR kept high previously. As for the reasons, over more than one decade, China maintained the status with capital inflows in most cases. Monetary base mainly came from funds outstanding for foreign exchange. The central bank withdrew monetary by raising RRR, creating and issuing central bank bill. Over last two years, due to appreciation of the US dollar, pressure of capital outflow was strengthened, and funds outstanding for foreign exchange decreased. Meanwhile, along with liberation in China’s capital account, demand for bidirectional flow of capitals added, but funds outstanding for foreign exchange won’t increase in one way. There’s less necessity for the central bank to maintain high RRR. It needs to release liquidity through decreasing RRR and adopting new monetary policy tool.
(Translated by Coral Zhong, Vanessa Chen)