China: Softer monetary stance as a preventive shot in the arm to support economic growth
Alicia Garcia-Herrero 艾西亞
Chief Economist for Asia Pacific at Natixis
China will cut the reserve requirement ratio (RRR) by 50 bps, and the move is half expected and half surprising. What is anticipated is liquidity has been tight and the pressure on growth will be higher in H2 2021, meaning responses are needed to buffer the slowdown. What is surprising, though, is the approach and the timing of the change, which is a broad -based RRR cut before the data release of Q2 GDP. In this note, we analyze the implication of the softer monetary policy in China.
We think there are three reasons for the RRR cut. First, stronger support is needed for the economy, even if the policy tone has switched towards achieving sustainable growth. Second, inflation pressure has somewhat eased as shown by PPI in June. Third, China will face a record high maturity wall for the Medium-term Lending Facility (MLF) with RMB 1.7 trillion in Q3 2021 and RMB 2.45 trillion in Q4 2021. Unleashing liquidity is essential to keep the banking sector running smoothly.
Prima facie, the People's Bank of China (PBoC) can rollover or inject liquidity through the MLF. But a key difference of using the RRR is to have a wider impulse in the economy, especially as the cut is not targeted but broad-based for all banks. The move can help small banks and corporates the most, while the impact on large banks and firms will depend on how much liquidity the PBoC will drain from the upcoming MLF operations. This comes at a juncture that?banks face higher pressure with lower asset growth and net interest margin ?and RRR is less costly than MLF, meaning certain support for banking sector.
Although the RRR cut has sparked worries on weaker growth, there are only minor changes in government bond yields with limited response in SHIBOR and USDCNY. That said, the market does not expect big changes in monetary policy. But the key question is on the future. With a fading base effect and slower cyclical rebound, China’s monetary policy stance is likely to soften. China’s Q2 GDP data – which is a lagging indicator but due to release on 15th July – will be key to watch, but the economic data for July and development of the MLF operations in August may be even more relevant for the forward looking monetary policies. The PBoC may take a wait-and-see approach for now assuming the downside surprise is limited for Q2 2021, but more actions may be taken depending on the deceleration of economic growth.
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The soften monetary policy tone will have important market implications, especially for the RMB. The weaker economic data and more liquidity may weigh on the RMB, but the movement of the DXY is relevant. If the high US inflation is only temporary, the expectation for the FED to taper and hike rates may subside, especially if uncertainties persist in job creation and wage growth. In this context, the US dollar should resume its decline, but at a slower pace. For the RMB, it means the weaker dollar may outpace the pressure on RMB deprecation, meaning a moderate appreciation towards 6.37 in end-2021.
All in all, the monetary policy in China will remain neutral but soften slightly. The RRR cut is a preventive shot in the arm to buffer potential slowdown, but there is still plenty of room to adjust based on the future economic data, which will impact the degree of softening.
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