In a sign that China's ongoing attempts to delever (and decelerate) the economy may have gone a bit too far, on Saturday morning China’s central bank announced a targeted reserve requirement ratio (RRR) cut, its first since February 2016 and which will go into effect in 2018, in an attempt to boost lending to struggling smaller firms and energize China's lacklustre private sector, Xinhua reported.
The People’s Bank of China said on its website that it would cut the reserve requirement ratio for some banks that meet certain requirements for lending to small business and the agricultural sector. According to the PBOC, the vast majority of China’s banks would be eligible for at least a 50 bps cut to their required reserve ratio. As a reminder, the RRR is the amount of cash as a percentage of deposits that banks must park at the central bank as reserves. The current rate for major banks was set at 17.0% after the last general RRR cut that took effect in March 2016.
The PBOC explained that the reserve requirement rate will be cut by 50 bps for banks whose loans to the targeted groups account for 1.5% of their outstanding loan balance or their newly added loans for the previous year. A much higher bar is set for a further 100 bps cut: 10% of loans must be to the designated “inclusive finance” groups, the PBOC said. Banks that meet the 10% requirement will see their RRR cut by 150 bps.
The PBOC also said the move was made to encourage more small loans - those under 5 million yuan - to small firms, loans to individual proprietors and lending that supports agricultural production, innovation, the poor and education.
As the following chart show, the targeted RRR cut which is meant to stimulate credit creation by smaller banks comes at a time when smaller bank lending has slown substantially as a result of the ongoing crackdown on shadow banking products.
While the central bank explained that the "targeted" RRR cut is a structural adjustment that does not change the country's overall monetary policy stance, stressing that it would continue to implement "prudent and neutral" policy to guide reasonable credit and financing growth, analysts at Lianxun Securities said that "the size of the cut is big, it covers all big banks, and 90 percent of small and mid-sized banks. Conservatively we estimate 700 billion yuan in liquidity could be freed up."
Perhaps more notably, analysts observed that the cut was different from previous changes to RRR in that it was a “delayed” cut that will not go into effect until next year, which could lead to disappointment for a banking sector that has already seen significant liquidity withdrawn in recent weeks.
“Clearly, the market will be disappointed as this cut will not help ease the liquidity conditions in the onshore banking system in the short term,” Zhou Hao, a Singapore-based analyst at Commerzbank, wrote in a note after the announcement.
The RRR cut will likely not come as a surprise as China’s cabinet, gearing up for the most important Communist party Congress in 5 years starting next month, had recently flagged a possible move, saying "the government would take a number of measures, including tax exemptions and targeted reserve requirement ratio cuts to encourage banks to support small businesses."
The policy action is in line with ongoing attempts to delever the economy and encourage more targeted lending to more vulnerable sectors of the economy, even as the government tries to cut down on speculative investment in the financial sector and property and rein in a rapid buildup in overall corporate debt. However, the RRR cut is departure from the PBOC's recent approach of setting policy using new tools such as short- and medium-term lending facilities for a similar purpose....
... as well as daily changes to interbank liquidity via reverse repo open market operations.
Lianxun Securities also said the RRR cut would help to offset negative impacts to smaller firms from strict environmental protection measures and capacity cuts, while also offering some liquidity relief to small and mid-sized financial firms. Additionally, the move comes amid increasingly more aggressive attempts by China to delever its shadow banking system, which has plateaued over the past year.
As Deutsche Bank noted several days ago, in China's latest monthly credit data report "the financial deleveraging campaign has continued to make progresses: banking assets growth softened further; loan and TSF beat estimates but the overall credit growth actually moderated; shadow banking size was shrinking while loan growth stayed resilient. As such from the financial system’s perspective we see improving transparency and lower liquidity risks. While the deleveraging has contributed to a modestly slower economy, the growth momentum is in line with our house view."
That said, DB said that "we do not foresee policies to ease and we expect the deleveraging to carry on orderly," so one wonders how today's significant easing will impact the German bank's outlook on China's economy.
Separately, to offset the shrinkage in China's shadow banking sector, in February the PBOC extended a preferential programme that allows financial institutions that support rural finance and small enterprises to apply for a lower required level of cash reserves. But despite still-strong credit growth nationwide, many small businesses and farmers remain in desperate need of funds and do not have easy access to ample cheap credit that state-run firms enjoy.
Also on Saturday, the central bank said it will maintain prudent and neutral monetary policy and use multiple monetary policy tools to keep liquidity basically stable. The statement, which came after the third quarter meeting of the PBOC’s monetary policy committee, said "China will continue with interest rate and exchange rate reform while keeping the yuan basically stable."
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Finally, also on Saturday, China reported that its manufacturing PMI rose to 52.4 in September - more than the 51.5 expected and the highest print since April 2012 - as big factories ramped up faster than smaller ones, presumably a last piece of window dressing to show host "strong" the economy is ahead of the pivotal Communist Party meeting. The National Statistics Bureau attributed the surge to improving demand from domestic and overseas markets and to consumer-goods makers accelerating production ahead of a weeklong national holiday starting October 1. Some economists also said activity picked up thanks to production from Chinese exporters for the Christmas season and manufacturers bringing production forward to beat a government crackdown on pollution.
Ironically, as China's official manufacturing survey, which focuses on larger SOEs, came out scorching hot, a private measurement of factory activity, which more closely tracks smaller private companies, weakened. The Caixin China manufacturing purchasing managers’ index slipped to 51.0 in September from 51.6 in August, as new orders and output increased at a softer rate than the previous month, said Caixin Media Co. and research firm Markit.
Operating conditions in China's manufacturing sector softened in September, dragged down by the weakest rise in new business in three months and an easing in output to the lowest level since June, according to the latest Caixin Manufacturing Purchasing Managers' Index (PMI) released Saturday. The headline manufacturing PMI fell to 51.0 in September from 51.6 in August but remained above the 50 break-even mark for fourth consecutive month, according to data compiled by IHS Markit for Caixin.
Readings above 50 indicate expansion in the manufacturing sector while readings below 50 indicate contraction. The higher the PMI reading above 50, the faster the expansion in the sector. The lower the reading below 50, the faster the contraction.
The slowdown in the Caixin index -- which focuses on smaller and medium-size companies -- was in contrast to the sharp rise in the official manufacturing PMI jointly released today by the China Federation of Logistics and Purchasing and the National Bureau of Statistics. The CFLP/NBS PMI came in above expectations at 52.4 in September, the highest level since April 2012, due mainly to robust input and output prices.
The Caixin index showed that new business expanded at a slower pace due to the weak demand. "Notably, new export work increased only marginally during the latest survey period," Caixin said.
The chart below shows the latest divergence between the two series:
Lu Zhengwei, an economist with Industrial Bank, told the WSJ that the government crackdown to curb pollution falls heavier on smaller manufacturers, which usually have poorer emissions controls, hence the divergence between the gauges. However, in light of the ongoing plunge in China's credit impulse and the recent miss and slowdown across all major economic indicators, including industrial output, retail sales, foreign trade and fixed-asset investment, it is clear that the economy has begun to cool.
In response, the governing State Council recommended this past week that the amount of reserves big banks must set aside with the central bank should be lowered, provided they meet certain criteria on lending to small and private businesses. Zhou Jingtong, an economist with Bank of China , said it was a good time to lower the reserve requirement for some big banks to prevent the economy from decelerating too sharply.
That's precisely what happened this morning.