Window is Open For China to Ease Policy -- Barron's Blog

        By Haibin Zhu
        Our current forecast expects two RRR cuts and one more rate cut in 1H15. Given recent developments and liquidity dynamics, we expect the first reserve requirement ratio (RRR) cut (since May 2012) may come before the Chinese New Year (February 19). There are three reasons behind our argument.
        First, the macroeconomic developments justify monetary easing in the near term. Yesterday's data release shows that China's GDP growth stayed unchanged at 7.3% year-on-year in 4Q14 (vs. 3Q14), but in sequential term, the growth momentum weakened from 8.1% quarter-on-quarter seasonally adjusted annual rate (saar) in 3Q14 to 7.1% quarter-on-quarter saar in 4Q14 (the National Bureau of Statistics show a similar slowdown from 1.9% quarter-onquarter seasonally adjusted to 1.5% quarter-on-quarter seasonally adjusted not annualized). Meantime, Consumer Price Index (CPI) inflation stayed at a low level of 1.5% in December, and Producer Price Index (PPI) deflation continued for 34 months in a row (and PPI deflation has widened in recent months). Against such a backdrop, monetary easing, including RRR cuts, is fully justified to stabilize economic growth.
        Second, there could be concerns of liquidity shortage prior to the Chinese New Year, during which period liquidity demand will increase significantly. For instance, in 2014, in the four weeks prior to the Chinese New Year (January 31) the People's Bank of China (PBOC) injected 450 billion yuan liquidity (on a net basis) via open market operations and CNY190 billion via short-term liquidity funding (SLF). Such liquidity injection tends to be only temporary. In the four weeks after the Chinese New Year in 2014, the PBOC withdrew CNY818 billion liquidity in the open market and CNY220 billion liquidity via matured SLF, more than offsetting the liquidity injection before the lunar New Year. This is why some investors expect the PBOC will only inject temporary liquidity this time.
        However, the important difference this time is the dynamics of FX reserves. In 2014, FX reserve increased significantly and added permanent liquidity into the banking system. In particular, FX reserve rose by $31.9 billion, $45.3 billion and $47.1 billion, respectively, between December 2013 and February 2014 (a total of CNY760 billion). By contrast, FX reserves declined every month in 2H14 as the PBOC stopped intervention in the FX market (it fell by $4.3 billion in December 2014). Therefore, the traditional channel of injecting liquidity via FX reserve accumulation has been absent in recent quarters. This opens the possibility of injecting permanent liquidity via RRR cuts or alternative methods (e.g. public sector lending (PSL), medium term liquidity funding (MLF), re-lending). Meantime, it is worth noting that the PBOC has suspended open market operations since December 6 and only CNY30 billion liquidity was injected in the past seven weeks.
        Third, recent communication from the PBOC suggests that the central bank is not against RRR cuts, but it is concerned about the structural issues in monetary transmission, in particular, the liquidity injection will only benefit certain sectors (especially real estate and overcapacity industries) due to distortions in the credit market. The PBOC is also concerned that, if it cuts RRR, the market may mis-interpret it as a beginning of large-scale monetary easing.
        To that front, recent developments in regulatory measures are interesting. On January 16, the PBOC circulated a revised version of the loan-to-deposit ratio (LDR) calculation, which includes inter-bank loans in the LDR calculation. This almost fully canceled out the impact of an earlier announcement that includes inter-bank deposits in the LDR calculation (which tends to increase bank's lending capacity). Last weekend, the security regulator (CSRC) tightened rules on margin financing. In our interpretation, such measures aim to fill the holes in existing regulatory and supervisory framework, and pave the way for liquidity injection in the coming weeks.
        To summarize, we think the PBOC will very soon resume open market operations and will very likely announce a 50 basis points RRR cut in the coming weeks. Given the number of policy instruments available for the central bank, we cannot completely rule out the possibility of substituting RRR cuts with other instruments such as PSL and MLF.
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        Haibin Zhu is Chief China Economist and Head of Greater China Economic Research at J.P. Morgan based in Hong Kong.
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        (END) Dow Jones Newswires

        January 20, 2015 23:51 ET (04:51 GMT)

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