China has cut rates 5 times since November, including 4 full or partial RRR cuts since February. All those previous rate cuts did nothing to alter the downward glideslope of China's economy which recently recorded its worst manufacturing performance since Lehman, and while the Chinese stock market benefited briefly, soaring 60% by mid-June, it had since given up all gains and was down 7% as of this morning, when the PBOC "surprised" everyone with its 5th RRR cut. The cut was not surprising - everyone had predicted it - what was surprising is that the PBOC waited until after market close on Tuesday to announce it instead of doing it over the weekend, which would have avoided a 16% rout in stocks in the past 2 days.
So why did China proceed with its latest rate cut? Short answer: because it had no other choice with everything else that it has been micromanaging so far in shambles, even if it means risking another acceleration in capital outflows but the PBOC will worry about crossing that bridge when it gets to it... in a few days.
Here is Goldman's take:
PBOC cuts RRR and benchmark rate amid weakening economy, falling equity market and accelerating FX outflows
The PBOC has just announced that it will lower the benchmark lending and deposit interest rates by 25 bps (effective Aug 26) and the RRR (reserve requirement ratio) for all financial institutions by 50 bps (effective September 6).
Besides the cut in benchmark interest rates, the ceiling for deposit rates of time deposits of longer than one year will be removed (while the ceiling for demand deposits and time deposits of less than one year will remain unchanged). In addition to the broad RRR cut of 50 bps, an additional 50 bps cut will be applied for rural credit cooperative, rural commercial banks and village banks, and an additional 300 bps cut will be applied for financial leasing companies and auto financing companies (Our banking team estimates that total liquidity release will be around RMB 600 bn).
We believe the PBOC's move was mainly driven by the following:
- Activity growth weakened meaningfully after a brief rebound in 2Q. July activity data were disappointing. July IP sequential growth moderated to 3% mom ann from 10% mom ann in June. While we still need hard activity data to confirm, August activity growth has probably also been weak, as reflected in the Caixin manufacturing PMI flash reading. Shutdown of factories (from August 20 to September 4) around major international events will add further downward pressures on activity growth in August and September. The official GDP target of "around 7%" this year is clearly under threat, and policy easing measures therefore must be stepped up to support growth.
- Outflows re-emerged and drained liquidity. On the back of a weakening economy and FX rate devaluation, FX outflows re-emerged in July (see China: FX outflow re-emerged in July, Aug 18, 2015) and very likely worsened in August. The PBOC needs to keep at least a steady level of liquidity supply and interbank rate. The RRR cut is therefore called for to offset the liquidity drain from FX outflows. Compared with open market operations, the RRR cut sends a much clearer message about policy intention which is much needed.
- Equity market has been falling very rapidly. As of the time of writing, SHCOMP broke the 3000 level, down 16% from last Friday. We believe this decision to cut the RRR is also partly due to the recent equity market performance.
The liberalization of the long term (above 1 year) deposit rate is another positive step in the process of interest rate liberalization. The targeted RRR cuts will release some additional liquidity but the amount is likely to be modest compared to the broad 50bps cut.
These cuts are positive moves which are much needed to support the economy and market. But they are unlikely to be sufficient by themselves. Our baseline forecast is for another 100bp of RRR cuts by the end of the year, most likely in two moves--the exact timing will be data and market dependent. Further benchmark interest rate cuts are relatively less likely compared with further RRR cuts, in our view, given policy makers’ residual worry over inflation and concerns on FX outflows, though we still have another 25bp cut in our baseline. In our view, the interbank rate needs to fall at least back to its May level (closer to 2.0% pa in terms of the 7 day repo) though the PBOC has not given clear indication about whether and when it might do it. Besides monetary policies, fiscal and administrative policy support will likely be stepped up also. We will likely see more government bond issuance, better utilization of idle fiscal deposits, more support to policy banks, and administrative measures pushing for the implementation of these policies in the near term
