China’s cabinet unexpectedly signals RRR cut to step up financial support to real economy, lower borrowing costs

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China should use monetary policy tools such as cuts in banks’ reverser requirement ratio (RRR) in a timely way to step up financial support for the real economy, in particular for smaller companies, and lower borrowing costs, said the State Council, China’s cabinet, at a meeting chaired by Premier Li Keqiang on Wednesday.

China will lower financing costs for small companies to help them cope with rising commodity prices, the cabinet said. It added that the country will keep monetary policy stable and increasing policy effectiveness, but will not resort to flood-like stimulus.

The comments mark the first time that China’s top policymakers have signalled a RRR cut this year.

“The central bank is likely to unveil targeted RRR cut for smaller financial institutions which will more effectively increase support for smaller businesses,” said en Bin, chief researcher at the China Minsheng Bank.

“There is room for RRR cuts and it will also be necessary for banks, in particular smaller financial institutions. RRR cuts will release long-term funds and reduce financial institutions’ capital costs and in turn help guide them to further lower borrowing costs for the real economy,” said Wen.

In recent years, the PBOC mostly used Medium-Term Lending Facility (MLF) and open market operations to injects fund to the markets, but the funding usually has short terms than that released by RRR cuts and carries higher costs, Wen noted.

He added that as China’s producers’ price index is currently at a high level, so the central bank may choose the time based on inflation situation. “If inflation eases in June and July, end-September could be a good time window for unveiling RRR cut.”

After several rounds of RRR cuts since 2018, China’s average RRR for financial institutions currently stands at 9.4 per cent, down 5.2 percentage points from the level seen in early 2018, with RRR for large, medium and small banks is 11 per cent, 9 per cent and 6 per cent, respectively.

Earlier, former PBOC official Sheng Songcheng said in a column published late on Tuesday that China should guide market interest rates lower to support economic growth and ease funding pressure on local governments.

Reasonable rate cuts also would help create space for the PBOC to tighten policy if needed in the future, in order to cope with an expected weakening in the yuan, Sheng said.

“It’s necessary to keep liquidity reasonable and sufficient, and guide the rational and moderate decrease of market interest rates,” Sheng said, adding that economic growth is likely to slow to 5-6 per cent in the second half of the year, from an expected pace of around 8 per cent in April-June.

Policy tightening in the future will help ease depreciation pressure on the yuan caused by rising capital outflows from China once the U.S. Federal Reserve starts to tighten policy from emergency pandemic levels, Sheng said.

In June, the PBOC left its benchmark lending rate for corporate and household loans unchanged for the 14th straight month. It did not cut its key rates as sharply as many other central banks in the initial stages of the COVID-19 pandemic, as the government was quicker to roll out fiscal stimulus measures and aid to struggling companies.

According to a report released by the PBOC on May 11, weighed average interest rate on new bank loans in March increased by 0.07 percentage point to 5.1 per cent.

Ting Lu, chief China economist at Nomura, said on Wednesday that he expected the central bank to maintain a modest tightening stance, with no rate cuts or rises expected in the second half.

“China’s policy response towards the COVID-19 pandemic has been different from the past rounds of easing, and one key factor is the strength in exports so that policymakers did not need to resort to mass stimulus in property and infrastructure sectors,” he said.