China Central Bank Uses New Tactics on Gentle Easing Path
The laws of probability dictate that the longer China delays a widely-expected cut to the required reserve ratio (RRR) for its banks, the more likely it is to come.
Investors are getting twitchy, having been caught out over such a cut they had confidently predicted — but failed to see — in the run up to the Lunar New Year holiday last month.
Policymakers seem happy to keep them that way, defying expectations of a move and instead waiting as long, and pulling as many alternative levers as possible, to delay the first of what economists think could be many as six RRR cuts this year.
The People's Bank of China has opted for open market operations to inject short-term liquidity into the financial system in recent weeks, helping to keep credit flowing as growth in the world's second-biggest economy hits a sticky patch due to weak global demand.
Beijing is reluctant to give the green light to another bout of big bank lending while it is still gauging how deep or shallow the latest economic downturn is, especially as policymakers are still trying to soak up the credit excesses and inflationary pressures spawned by a 4 trillion yuan (401 billion pound) economic stimulus program in 2008.
"They are keen to hold things steady. I think they are poised if they have to do something, but I don't think they feel the shock is bad enough, yet," said Tim Condon, head of research at ING in Singapore.
"The fourth quarter was a bad quarter but I don't think it was bad enough to make them really scared. If it gets a lot worse, I'm sure we'll see them moving. It's tough in Q1... the economy is going to be more difficult than usual. "
Difficult yes, but the intensity of the economic headwinds are nowhere near as severe as in the 2008 financial crisis.
Which helps explain why the central bank used two 14-day reverse repurchase operations just ahead of the New Year holidays to meet surging demands for cash.
The 352 billion yuan injected into the system was roughly equivalent to the 350-400 billion yuan delivered by the 50 basis point RRR cut announced on Nov 30, the first in three years. That move took the rate down from a record 21.5 percent.
Investors believe the central bank also conducted reverse repos with individual banks.
"It seems that the PBOC wants to signal its prudent stance. It does not want the market to get a wrong idea that the new year means more credit," said Wei Yao, China economist at Societe Generale in Hong Kong.
"And they are more willing to accept more slowdown and refrain themselves from over-stimulating the economy — basically the same mistake they made years ago."
The reserve ratio cut for big banks has been followed by a gradual relaxation of some controls on credit at smaller regional institutions in recent months to support the slowing economy.
Meanwhile, the deep-pocketed government has focused more on cutting taxes and red tape for the small businesses that provide about 75 percent of the jobs in China.
By opting for reverse repos — through which the central bank injects cash by buying securities from banks and then selling them back at a set date — policymakers get more time to judge policy while faced with uncertain economic evidence.
Injecting liquidity via reverse repos also helps smooth out volatility in cash demands without spooking the market and sending a confusing signal on a potential policy shift.
"It's a flexible tool, you can correct it in the afternoon if you made mistakes in the morning. But if you make a mistake in RRR, it could cause a big market impact," said Gao Shanwen, chief economist at China Essence Securities in Beijing.
The central bank's caution is justified, with many uncertainties on the horizon, such as whether Europe can muddle through its debt crisis, if the U.S. recovery can gain traction and whether inflation is reignited if commodity prices rebound.
The government is due to release inflation and trade data this week but some of the numbers may be distorted by the timing of Lunar New Year, which was in January this year and in February last year. During the week-long celebrations, factories shut or run at half speed.
In March, the government will release combined factory output, investment and retail sales data for January and February to smooth out seasonal distortions.
Few analysts believe the central bank will cut interest rate cuts this year, with annual inflation staying stubbornly higher than the one-year deposit rate of 3.5 percent.
However, it faces limited options but to reduce RRR further to help offset an expected decline in capital inflows that will put strains on its ability to generate enough money supply to support economic growth, analysts say.
"Overall, reverse repos as a short-term liquidity management policy will play a bigger role, but they will not replace a cut in RRR," said Peng Wensheng, chief economist at CICC in Beijing.
"The central bank is likely to issue reverse repos with longer maturities to ease liquidity conditions, but it still needs to cut RRR multi-times this year to offset the decline in FX purchases growth," he said in a note to clients.
A Reuters poll conducted last month showed the central bank may cut the reserve ratio by a total of 200 bps throughout 2012 to 19 percent.
Analysts seem to be sticking to their forecasts so far.
They say the biggest uncertainty facing the central bank is not economic growth, but capital flows as they determine the level of base money and need to cut RRR.
China's economy has surfed for years on a crest of hefty capital inflows, but the tide suddenly turned late last year as mounting global risks led some investors to withdraw funds.
Central bank foreign exchange data revealed net capital outflows of 100.3 billion yuan in December, 27.9 billion yuan in November and 24.9 billion yuan in October.
Some analysts reckon capital outflows may have eased in January and February, reducing the need to cut RRR.
But Peng at CICC reckons that net inflows could nearly halve to about 1.5 trillion yuan in 2012 from last year, suggesting the central bank has to pump out the balance to compensate for the fall in the monetary base.
The government has set a target of 8 trillion yuan in new loans and 14 percent growth in broad M2 money supply for 2012, sources familiar with government plans told Reuters last month. That marks a rise from 7.47 trillion yuan in new bank loans and annual M2 growth of 13.6 percent in 2011.
The government also aims for 7.5 percent GDP growth this year and 4 percent annual inflation, the sources said, moderating from 9.2 percent GDP growth in 2011 and 5.4 percent inflation.