Are markets over-egging the impact of China's move to cut the reserve requirement ratio (RRR) by 50bp over the weekend? After all, the cut was designed to soften, somewhat, previous policy hikes rather than a case of overt net easing, according to Credit Suisse. In fact, the analysts there reckon that interest rate hikes, rather than cuts, could be on the horizon to balance the trade-off between growth and inflation.
Of course, other things being equal, a loosening of the RRR will add more liquidity into the system. But don't read too much into this point - it's a matter of monetary fine-tuning of quantitative rather than price tools of monetary policy, according to CS.
| The RRR cut was widely expected and represents a technical adjustment rather than a change in monetary policy stance, in our view. In fact, we think the cut was originally planned for last week but was postponed when CPI inflation in January surprised on the upside. The PBoC has long been arguing that, since banks were asked to bring part of their off-balance sheet activities back onto their books, no cut in the RRR would mean a de-facto hike in the reserves ratio. The adjustment to the RRR is merely aimed at neutralizing some of the policy actions, instead of being a policy easing, in our judgment. |
In other words, it's more a gesture than real policy easing. In fact, most analysts had originally anticipated an RRR cut a month ago - before Chinese New Year - and there was some surprise when this didn't happen. However, the recent spate of poor economic data and political considerations may finally have forced the Chinese central bank's hand. From Credit Suisse again.
| In our view, a cut in the RRR now is an attempt to further stabilize growth and the stock market ahead of the National People’s Congress meeting that starts on 5 March...In reality, the PBoC has been more active in terms of fine-tuning liquidity conditions through open market operations, which are a low profile policy tool that can adjust bank liquidity frequently and effectively. |
In Capital Economics' words:
| China's January data did not provide much of a steer on the strength of the economy -- inflation was higher than expected and imports weaker, but both may have been distorted by the Chinese New Year holiday. |
To be fair to CS, it reckons RRR cuts, will, at the margin, reduce hard landing risks but only to a point.
| Cutting the RRR at the margin does reduce the risk of a hard landing, and has a positive impact especially on the ability of smaller banks to lend. However, this may not lead to a strong rebound in growth, in our view, because: 1) the easing in lending has been selective and measured; 2) the organic demand for lending (outside of the property sector) seems to be shrinking; and 3) the property sector remains a key risk for the economy. This RRR cut does not change our view that the economy is likely to grow in the range of 7% to 8.5% in quarter-on-quarter annualized terms this year, assuming more fiscal stimulus is introduced. |
So RRR easing, yes - and another 5% cut is likely in the second quarter of the year - but policy normalization must be on the cards and so interest rate hikes loom, according to CS.
| We believe that the next move for interest rates will be up instead of down. China’s interest rates are merely a touch away from their historically (and excessively) lowest levels. Inflation is at 4.5% while the one- year time deposit rate is at 3.5%. Without a rate hike, we think banks’ deposit bases will continue to erode, as they have done over the past six months. Without a rate hike, businesspeople will be less interested in investing in real businesses given the wrong price signals about funding. Cutting the reserves ratio while raising interest rates appears to us to be consistent with the statement repeated by the central bank about striking a better balance between the quantitative (RRR) and price (interest rate) tools of monetary policy. However, the timing of an interest rate hike will depend on domestic growth conditions and global financial risks. We now expect two hikes in the one-year deposit rate and one hike in the one-year lending rate, possibly starting from 2H 2012. Furthermore, we expect the trend of interest rate increases and a narrowing interest rate spread to accelerate next year, in the name of interest rate deregulation. |
Rising rates in China would come as a surprise to most investors, who are focused more on the risks of a slowdown and what steps might be needed to stimulate the economy. But if it happens ... don't say you weren't warned.