China reserve-ratio cut signals growth is priority over yuan

A man walks past the headquarters of the People's Bank of China, in Beijing, on Jan 19, 2016.
A man walks past the headquarters of the People's Bank of China, in Beijing, on Jan 19, 2016. PHOTO: REUTERS

BEIJING (BLOOMBERG) - China's latest easing move signals that shoring up growth is the government's top priority even if doing so further weakens the yuan or adds to leverage that threatens the longer-term health of the world's second-biggest economy.

The People's Bank of China said Monday (Feb 29) that it's cutting the amount of cash the nation's lenders must lock away. The move marked the first time in four months that the central bank has used one of its traditional monetary-easing tools, despite mounting signs of a weaker economy and a stock market in near- freefall. The official factory gauge released Tuesday (March 1) extended its stretch of deteriorating conditions to a record seven months.

The action came days before Premier Li Keqiang is expected to set the bar lower for gross domestic product with a 2016 target expansion range of 6.5 per cent to 7 per cent, compared with last year's goal of around 7 per cent. The renewed focus on growth could be at the expense of any effort to rein in ever- increasing debt: Chinese banks extended a record amount of new loans in January. Meantime, the yuan is down 3.6 per cent against the dollar since October.

"This move suggests that, in the end, supporting growth takes priority over other considerations," Louis Kuijs, chief Asia economist at Oxford Economics in Hong Kong, said in a note. "Today's move matters in terms of what it signals about the policy direction," said Mr Kuijs, who formerly worked at the World Bank and International Monetary Fund.

PBOC Governor Zhou Xiaochuan highlighted scope for further action ahead of a Group of 20 meeting in Shanghai last week, saying China had "multiple policy instruments" to address growth risks. The half percentage-point cut in the required reserve ratio will inject about 685 billion yuan (S$146.98 billion) into the financial system, Bloomberg Intelligence estimated.

Whether that money actually stimulates the economy is another matter. Credit Suisse Group economist Tao Dong said the impact depends on how much banks are willing to lend to home buyers.

Roberto Perli, a former Fed official who's now a partner at Cornerstone Macro LLC in Washington, said in a note that the action probably isn't a "net monetary easing" because it replaces temporary cash injections. Or, as University of California at San Diego professor Victor Shih says, the move merely counteracts money outflows of recent months.

"It looks a bit desperate," said Alicia Garcia Herrero, chief Asia Pacific economist at Natixis SA in Hong Kong. "Zhou already said that he would use monetary policy as much as needed to support growth, so this basically means that growth is still not coming naturally with the already lax monetary conditions."

The official manufacturing purchasing managers index dropped to 49 in February, missing the median estimate and falling to the weakest since January 2009. Numbers below 50 indicate conditions worsened. Another PMI gauge from Caixin Media and Markit Economics also declined, falling to 48 from 48.4 in January and to the lowest since September 2015. The Shanghai Composite Index climbed 0.3 per cent as of 10 am local time. Hong Kong shares also advanced.

China may not be done easing. The latest cut takes the ratio to 17 per cent for the biggest banks, still one of the highest such levels in the world.

The central bank said it lowered the reserve ratio to guide stable and appropriate growth in credit.

"This is unlikely to be the last RRR cut," said Tim Condon, head of Asian research at ING Groep NV in Singapore. "The question is, how long does it take for them to follow up with an interest-rate cut."

China is facing no shortage of difficulties in its economy and markets. The Shanghai Composite Index has declined 24 per cent this year, the worst performer among 93 global equity indexes. Foreign-exchange reserves have plummeted US$762 billion since mid-2014 as the government tried to defend a falling yuan.

Injecting stimulus in the form of debt may make things worse in the long run. Goldman Sachs' investment management division has warned that China's debt-to-GDP ratio increase is among the highest in recent history. Debt will peak at 283 per cent of GDP in the coming years, according to the median estimate of eight economists in a Bloomberg News survey published in February.

"The PBOC needs to walk a fine line," Oxford's Kuijs said.