MNI ANALYSIS: China RRR Cut Raises Questions on PBOC Policy

By Nerys Avery

     LONDON (MNI) - Less than two weeks after S&P Global Ratings cut China's

sovereign credit rating over concerns about the rapid expansion of the country's

debt , the People's Bank of China appears to be opening the floodgates to

another surge of lending, ostensibly under the government's "inclusive finance"

campaign.

     The PBOC said it will make selective reductions to banks' reserve

requirement ratios (RRR) starting from Jan. 1, 2018 based on how much they

loaned in 2017 to small and micro enterprises and to other borrowers that fall

under the government's "inclusive finance" label. This includes the agriculture

sector, start-ups, students and those living below the poverty line.

     Analysts' estimates of the amount of money the cuts will flush into the

financial system range from CNY300 billion to CNY800 billion, but the final

figure could be much higher. That gives naysayers plenty of ammunition to shoot

down both the central bank's insistence that it is following a prudent and

neutral monetary policy and the government's campaign to rein in leverage in the

financial sector and curb financial risks.

     However, the lower reserve requirements may not be as much of a monetary

loosening as first appears. The central bank may be trying to ward off a crunch

in bank liquidity early next year that could result from the tightening of

banks' access to wholesale funding through the sale of Negotiable Certificates

of Deposit (NCD) and a change in the classification of NCD on lenders' balance

sheets. The PBOC may also have decided to permanently replace some of the

liquidity lost from the financial system over the past two-and-a-half years

through capital outflows.

     The central bank reverted to its bad old habits last week, making the

announcement not only on a Saturday evening but at the beginning of a week-long

public holiday on the Chinese mainland. In a way, the timing was understandable

- the PBOC probably wanted to avoid triggering any unwanted volatility in

domestic markets by giving them time to digest a rather bizarre twist on its

reserve requirement ratio policy that could be interpreted as a significant

climb-down from its longstanding financial deleveraging and liquidity tightening

campaigns.

     CNY22 TRILLION LOCKED UP

     According to the PBOC statement, banks who can show that 1.5% of their new

loans in 2017, or 1.5% of outstanding loans at end-2017, were made to these

targeted sectors will get a 50 basis-point reduction in their RRR from Jan. 1.

Those who can show that 10% or more of their new loans, or 10% of their

outstanding loans, have gone to those sectors will get an additional 100

basis-point reduction.

     The RRR for the country's biggest banks currently stands at 17% of total

eligible deposits, although the central bank operates a differentiated policy

that gives some banks a rate as low as 15% if they meet certain criteria. Fitch

Ratings says there's about CNY22 trillion of RRR money locked up at the central

bank.

     The PBOC said that all large and medium-sized banks, 90% of city commercial

banks and 95% of rural commercial banks are already eligible for the 50

basis-point cut. But it didn't give an indication of the number of banks who

would qualify for the bigger cut. Neither did it put a figure on the amount of

liquidity that might be released.

     The PBOC said the decision to cut reserve requirement ratios for loans to

its targeted sectors represented a "structural adjustment" and should not be

interpreted as a shift away from its prudent and neutral monetary policy. "The

targeted ratio cut is an incentive mechanism to allocate more financial

resources to inclusive finance and optimize the lending structure," it said.

     Societe Generale estimates the move will free up at least CNY800 billion of

liquidity, assuming unchanged deposit growth in the fourth quarter. Analysts at

Chinese brokerage Lianxun Securities put the amount at CNY700 billion.

     Morgan Stanley's economists estimate the liquidity injection at only an

incremental CNY300 billion next year because, they say, the move is not a

broad-based RRR reduction but a targeted one that only makes more banks eligible

to benefit from a policy that started in 2014. They say that while most banks

will qualify for the first 50 basis-point cut, getting the extra 100 basis-point

cut will be hard to achieve, especially given there are only three months left

to achieve that target.

     However, in theory, if all banks qualified for the entire 150 basis-point

reduction, that could amount to anything between CNY1.4 trillion and CNY2

trillion of liquidity potentially available for lending, depending on whose

estimates are used for the total amount of eligible bank deposits held as RRR at

the central bank. Given banks' ingenuity in finding ways to game the system,

that's not entirely impossible. To put the figures into context, banks doled out

roughly CNY10 trillion in new loans in the first eight months of this year.

     POLICY BUZZWORD

     Inclusive finance has become a buzzword in policy making circles over the

last few months as the government has sought to push more lending into the real

economy to support growth and to stop investors from using idle funds to

leverage up and speculate in financial markets. In May, China's large commercial

banks were told to set up inclusive finance departments to support small

companies, agriculture, poverty relief and entrepreneurship by the end of 2017.

     The prospect of a 150 basis-point cut in their RRR is a significant

incentive for banks to lend to the government's targeted sectors. And it's

especially attractive for smaller lenders who are suffering from liquidity

shortages as a result of the central bank's campaign to curb financial leverage,

which has tightened wholesale funding availability in the interbank market and

pushed money-market rates higher.

     Banks' access to wholesale funding through the interbank market looks like

it will be curtailed next year. The central bank banned the sale of NCD with

tenors of more than one year starting from Sept. 1, and will force banks with

assets of more than CNY500 billion to include them as interbank liabilities on

their balance sheets from Jan. 1, 2018. Under the PBOC's Macro Prudential

Assessment criteria, interbank liabilities are limited to a third of total

liabilities so the shifting of NCD into that category will reduce the amount of

certificates banks can issue to raise funds. Faced with a potential squeeze on

liquidity, a cut in the RRR would provide welcome relief for many banks.

     Though PBOC denied the RRR cut represents a shift its monetary policy

stance, it's a stretch to believe that, given the amount of liquidity the move

could release and the central bank's publicly-stated opposition to using the

ratio as a monetary policy tool for the last couple of years.

     The last across-the-board reserve-ratio cut was announced in February 2016,

and officials have repeatedly said that a reduction would send too big a signal

of easing and would exacerbate capital outflows. Although there have been a few

small targeted RRR cuts, the central bank has mostly relied on open-market

operations and targeted loans through its Medium-term Lending Facility to manage

liquidity. While the central bank is claiming this latest RRR move is a targeted

reduction, it's hard to take that seriously when the PBOC itself admits that

nearly all banks will benefit from at least a 50 basis-point cut.

     One also has to wonder whether the PBOC is really serious about being

prudent and reining in financial risks if it is encouraging banks to lend to

SMEs, start-ups and the agriculture sector - customers that are traditionally

among the most risky and don't have the collateral that banks in China usually

demand.

     But the RRR cut demonstrates once again that the Chinese central bank is

not independent and must follow the orders of the government and the ruling

Communist Party, whether it likes it or not. The State Council statement posted

on the government's website three days before the PBOC's announcement gives some

indication that this is a political decision stemming from growing concern about

job creation.

     "Small and micro businesses have been a strong pillar for employment,

offering strong support for large and medium enterprises, and increased the

vitality of society," Premier Li Keqiang was quoted as saying. "We should

encourage financial institutions to lower their requirements and strengthen

capacities to serve the real economy."

     The statement said small and micro companies have played a pivotal role in

creating new jobs, and cited data from the National Bureau of Statistics that

each small and micro enterprise could help create eight new jobs.

     The message seems to be that policymakers are determined to force money to

flow to sectors of the economy that they believe will create jobs to sustain

growth and maintain social stability. They also want to boost support for the

government's mass entrepreneurship and innovation strategies. These are aimed at

encouraging people to set up their own companies with innovative business ideas

to keep economic growth humming as government measures to tackle industrial

overcapacity, state-owned enterprise reform and pollution damp the country's

traditional growth drivers.

     Whatever the rationale for the cut in reserve requirement ratios, it will

do little to boost confidence that the Chinese authorities are serious about

tackling their credit growth and debt problems.

--MNI Beijing Bureau; +44 203-586-2244; email: nerys.avery@marketnews.com

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