MNI INSIGHT: China Policy Advisors Advocate Further RRR Cut

     LONDON (MNI) - A consensus is building amongst policy advisors that China's

current required reserve ratio (RRR) is still too high and needs to be urgently

cut to a normal level, MNI understands. 

     A well-known PBOC advisor told MNI that the People's Bank of China will

probably cut the RRR again this year. 

     Additionally, MNI learned that many policy advisors advocate a significant

reduction in the RRR, as it would greatly inject capital into the system without

the need to expand the entire size of the credit pool.

     Under the background of boosting domestic demand, a continued 'neutral'

stance of monetary policy and a continuance of the deleveraging push, a further

RRR cut should be put on agenda. 

     --FUNDING COST

     The current high RRR level was an expedient measure the PBOC took before

2014 to frozen liquidity as foreign exchange reserves surged on the yuan's big

appreciation then, which has formed the well-known "Zhou Xiaochuan's Capital

Pool". The accurate amount of the pool remains unknown, but according to public

statistic published by the PBOC, MNI calculated the pool may be as much as CNY20

trillion.

     This unnecessarily high liquidity buffer is now constraining financial

activities. Under current regulations, banks have to hold about 14% to 16% of

their deposits in reserve, a further 5% as excess reserves, an 11% capital

adequacy ratio, and around 1% as so-called probation coverage ratio. In effect,

banks can only use about 60% of their capital. 

     What is more, the rate of deposit reserve is just 1.62%, far less than

market rates, so banks have to find ways to bypass regulations to earn higher

interest, which has generating messy shadow banking transactions, fuelling a

sharp pick-up in liquidity demand.  

     The PBOC has to open its floodgates from time to time to prevent a

liquidity crunch, which could easily disrupt the pace of interest rates reform. 

     Financial regulation also requires banks to squeeze off-balance sheet

business and force assets back onto the balance sheet, means liabilities also

need to expand. But with restrictions on wealth management products and the low

deposit interest rate, banks are struggling to meet the target. An RRR cut seems

the most effective rescue measure. 

     --OUTSIDE EFFECTS

     Higher interest rates in the U.S. and elsewhere pressures china's financial

market and real economy. The PBOC needs a monetary instrument to meet liquidity

demand while imposing only minimum impact on market rates, so an RRR cut will be

a buffer against the overspill effect of foreign monetary policies.

     As the current account surplus narrows and even shows a deficit, the

earlier way of relaxing PBOC liquidity via forex conversion is out of fashion.

leaving an RRR cut as a realistic substitute.

--MNI London Bureau; tel: +44 203-586-2225; email: les.commons@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

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