China starts easing monetary policy. Or does it?
CHINESE investors often refer in jest to the central bank as “central mama”. The idea is that it can be counted on to provide tender love—that is, policy easing—when market conditions are rough. But during the past couple of years it has been more of a disciplinarian, taking cash away from reckless investors. Its latest move, a cut of banks’ required reserves, has triggered a debate about which school of parenting it subscribes to these days. Is central mama turning soft again, or is she still cracking the whip?
On June 24th the People’s Bank of China said it would reduce the portion of cash that most banks must hold in reserve by 50 basis points. This was equivalent to deploying 700bn yuan ($ 106bn) in the financial system, or nearly 1% of GDP, which might sound like a healthy dose of liquidity to shore up growth. But the central bank insisted that it was not easing policy.
Many analysts take the central bank at its word. In the past, when it focused on the quantity of money in the economy, reducing required reserves could be seen as a form of loosening. But in recent years it has placed more emphasis on interest rates. Its most important target is banks’ short-term cost of borrowing from each other. That remained stable over the past week at about 2.8% in annual terms, proof that the announcement had little discernible impact.
Moreover, the main weapon in the central bank’s arsenal this year has not been monetary tightening but stricter regulation. It has, for example, forced banks to bring off-balance-sheet loans onto their books. There is no sign that officials are about to reverse these policies, which are at the heart of their campaign to rein in debt. E Yongjian of Bank of Communications, a Chinese bank, says cuts in required reserves can, over the long term, be viewed as policy normalisation. China used to rely on reserves to neutralise the inflationary effect of money flowing in from its whopping trade surplus. Even after the latest cut, banks must park 15.5% of their assets at the central bank as reserves, earning meagre interest. But with China’s current-account surplus steadily shrinking, the central bank has started to release this pent-up liquidity.
The counterargument is that, despite the central bank’s protests, the timing and manner of these cuts matter. The latest move stood out. In April it also cut the reserve requirement ratio, and by twice as much: 100 basis points. Yet that was more of a technical adjustment. The cash injection was mostly cancelled out by the central bank’s withdrawal of liquidity from another channel. This time, all of the 700bn yuan freed up was available for banks to use. The central bank specified that it wanted them to step up the pace of swapping corporate loans into equity stakes (part of China’s strategy for paring its debts). But as Julian Evans-Pritchard of Capital Economics, a consultancy, notes, this amounts to a “convenient excuse”, allowing China to inject large amounts of liquidity without abandoning its commitment to tackling financial risks. Analysts with Nomura called it a “clear signal of policy easing”.
The stockmarket, in so far as rationality can be ascribed to it, came down on the side of those saying that the central bank has not really started to ease. Prices continued to fall, taking the benchmark Shanghai index down more by than 20% since January. Technically, that makes this a bear market. Should the tumbles continue, it may not be long before central mama puts her more indulgent side on full display.
This article appeared in the Finance and economics section of the print edition under the headline “Mama’s love”