How to Interpret China's January RRR cut?

Date: January 25, 2024

There’s more to it than meets the eye

People’s Bank of China (PBOC) Governor, Pan Gongsheng, said during a press conference on Wednesday January 24 that the bank would lower the Required Reserve Ratio (RRR) by 50 bp, starting February 5. That should free up around 1 trillion yuan (USD 140 billion) in liquidity, which will be put toward supporting new loan growth.

The move is quite unprecedented, as the decision to cut the RRR is typically announced in writing by the State Council. We think PBOC’s haste in announcing the cut denotes urgency on behalf of policymakers, following an extraordinary rout in Chinese equities in January. Although these have recovered some losses over the past days, the Hang Seng Index remains down -6.2% YTD, while the Shanghai Composite is down -5.08% YTD.

Why does this matter?

The sell-off has eroded domestic sentiment, which could drag on consumption in 2024. More importantly, capital markets play a critical role in promoting China’s technological development, as many companies in so-called “new economy” sectors will need to tap capital markets in order to finance their expansion, both at home and overseas. Without a fully functioning capital market, many of these technologies will never see the light of day.

To this avail, Bloomberg reported that the central government was mulling a rescue package for domestic equities. The article mentioned that policymakers were seeking to mobilise 2 trillion yuan (USD 280 billion) from offshore accounts of state-owned enterprises, and would redeploy these funds to purchase onshore ETFs through the Hong Kong stock connect. This possibility seems rather farfetched. The rumour resurfaces every few months, but has not yet been verified by official sources.

Admittedly, the “national team” seems to have intervened to stabilize the market through ETF purchases since last week. However, the objective is to reverse some of the technical factors behind the recent sell-off, not to engineer a bull-rally in Chinese equities. Upside catalysts continue to be limited, meaning that a V-shaped rebound remains unlikely for now.

Against this backdrop, it is safe to assume that policy easing will continue to be desperately needed to ensure the economic recovery is secured in 2024. However, the onus will be on fiscal. Due to pressures on the foreign exchange front and concerns around the sustainability of Local Government Financing Vehicle (LGFV) debt, we think that monetary policy support will likely take a background role in 2024.

Next steps

We are not expecting Medium Term Lending Facility (MLF) or Loan Prime Rate (LPR) cuts in 2024. There are issues in monetary policy transmission, which would render any prospective interest rate cuts ineffective anyways. Moreover, President Xi reiterated that money growth should be “fundamentally in line with nominal GDP” at the December Central Economic Work Conference. That entails a deceleration in M2 growth from around 10% in 2023 to 6% in 2024.

The good news is that the PBOC has room to cut RRR further. At 10%, China’s RRR remains high by global standards (U.S. 0.00%; Switzerland 2.50%; India 4.50%). The yuan no longer faces structural factors exerting appreciatory pressures, so there is no need to maintain such an elevated RRR. On the contrary, the funds can and should be put towards ensuring there’s ample liquidity in the system.

What’s more, the additional liquidity from the RRR cuts can also help to alleviate pressures in the interbank market, following a squeeze in the second half of 2023. The 3-month SHIBOR rate pierced above the top bound of China’s “interest rate corridor” in the past weeks, which doesn’t help with investments. We expect a total of 100 bp in RRR cuts in 2024, but risks are tilted to the upside.

In sum, although the “national team” will play a role in stabilizing the market, the main driver of Chinese equity performance looking forwards will be earnings. In the absence of strong earnings momentum, it will be difficult for Chinese equities to rally enough to offset weak sentiment and exogenous factors such as geopolitical risks. Our GDP forecast for 2024 remains unchanged at 4.5%, which is no easy feat and will require sustained policy support. That points to mid-single digit EPS growth in 2024 (vs consensus 14%).

This article is based on an earlier report by UBP