China: the Cautious Monetary Easing

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October 4, 2012

Asia Economics Flash
Economics Research

China: The cautious monetary easing
Asymmetric use of the RRR
The PBOC has cut the reserve requirement ratio (RRR) only moderately during the recent easing, and instead relied on open market operations to counter the liquidity reduction from dwindling balance of payments surpluses. This contrasts with the aggressive use of RRR hikes during the tightening phase in 2006-2008 and 2010-2011. Li Cui

+852-2978-0784 li.cui@gs.com Goldman Sachs (Asia) L.L.C.

MK Tang
+852-2978-6634 mk.tang@gs.com Goldman Sachs (Asia) L.L.C.

Consistent with a cautious monetary policy stance
This asymmetric approach has helped ease the quantity of available funding and allow the economy (including local government platforms) to re-leverage, without a substantial further easing of broad funding costs. Yu Song

+86(10)6627-3111 yu.song@ghsl.cn Beijing Gao Hua Securities Company Limited

Holding the RRR cuts
A number of factors are likely to hold back further RRR cuts. First, monetary policy makers may judge the decline in BOP surpluses as temporary. Second, policy makers may be concerned about inflation and asset price risks. And third, there may be a preference to use more flexible tools such as reverse repo to meet liquidity needs. These suggest that RRR cuts are less likely to be used as an easing tool in coming months.

Yin Zhang
+86(10)6627-3112 yin.zhang@ghsl.cn Beijing Gao Hua Securities Company Limited

What will change it?
RRR’s role as a signaling device sets it apart from other liquidity instruments, and it can be used to boost sentiment if growth is much weaker than expected. Catalysts for RRR cuts could include a sharp slowdown in trade balance or a substantial easing of property prices and inflation concerns.

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Goldman Sachs

October 4, 2012

Asia Economics Flash

China: The cautious monetary easing
Asymmetric use of RRR changes
The People’s Bank of China’s (PBOC) policy objectives and tools have been in focus lately, in light of the decline in balance of payments (BOP) inflows. In China’s managed exchange rate framework, foreign currency inflows from the BOP surplus were the key driver of monetary aggregates in the past. Foreign currency inflows are purchased by the PBOC from commercial banks, and the corresponding increases of commercial banks’ CNY assets represent an increase in the monetary base. To manage the impact of BOP surpluses on domestic money growth, the PBOC often has to sterilize the inflows by bond issuances, open market operations (OMOs), and hikes in reserve requirements for commercial banks. Though reserve accumulation and sterilization has been ongoing for most years since 2004, the composition of the BOP surpluses has shifted over this period. Before 2008, trade and capital flows both contributed strongly to the BOP surpluses. During 2009-2011, trade surpluses declined from earlier years but capital inflows rose, in part due to depressed global yields and expected CNY appreciation. In that context, 2012 marked a departure from the earlier experiences. The trade balance and FDI have improved since 2Q2012. However, BOP flows diminished sharply, driven largely by capital outflows. To maintain the desired rate of monetary growth, the PBOC had to inject liquidity on a large and sustained basis.

During the tightening cycle in the past, reserve requirement ratio (RRR) hikes were one of the key tools used for sterilization. The RRR rose from 7.5% in 2006 to 15% in 2008, before modest cuts, and climbed again since late-2009 to stand at around 20% in early-2012. In the tightening phase during 2010-2011, RRR hikes withdrew more than 100% of the liquidity inflows from the rise...
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