The PBoC announced another relatively broad-based 50bp RRR cut, effective July five 2018. Shortly following the "not-so-targeted" RRR cut/MLF swap on April 25, the central bank of China announced on its website this afternoon (Sunday, June 24), that it will lower the reserve requirement ratio (RRR) by another 50bp for the “Big-5” banks, 12 shareholding banks, China Postal Savings Bank (CPSB), and a number of smaller deposit taking institutions. The central bank specified on its website that the 50bp RRR cut for the "big-5" (ICBC, CCB, BoC, ABC, BoCom) and 12 shareholding banks (including CITIC Bank and China Everbright Bank) aims at facilitating the debt-to-equity swap program, while the 50bp cut for the rest of the depository institutions is intended to increase the supply of credit to SMEs. These institutions include CPSB, city commercial banks, above-county-level rural commercial banks, and foreign commercial banks in China. This is the fourth time that the PBoC has effectively lowered the RRR since September last year, including the targeted RRR cut announced on September 30, 2017, and the Contingent RRR Arrangement (CRA) over the Lunar New Year of 2018, and the RRR cut/MLF swap just two months ago. In a statement following the announcement, the central bank revealed that the total amount of liquidity released from this cut will total Rmb700bn (Rmb500bn for debt-to-equity swap & Rmb200bn to replenish SME credit supply). According to our estimate, although "targeted" on paper, the effect of this RRR cut is close to a broad-based RRR cut, which releases around Rmb740bn in liquidity.

Rmb500bn of the liquidity released from this RRR cut will be used to facilitate debt-to-equity swap projects already approved (but yet to be executed), mainly for the state-owned corporate sector. In the announcement, the central bank detailed the guidelines for the debt-to-equity (DTE) swap program, including the following 1) the program is not applicable to “zombie” firms or projects with debt “disguised” as equity; 2) the government should encourage other entities to match the banks’ funding at a ratio of 1:1 or above (as banks’ share in DTE swap funding should ideally be <50%); 3) the pricing of DTE swaps should be market-oriented in principle; 4) the participating (non-bank) entities should also participate in the management of the targeted companies after the swap, in order to propel mixed ownership reform. The PBoC also specified that the funds released from RRR will be monitored, with every DTE transaction documented and submitted for review on a quarterly basis. It was reported that up to the end of 2017, a total of 102 companies have signed up for DTE swap programs with a total amount of Rmb1.6 trillion, but only around 20% (or Rmb300bn) of the swap has been executed so far.

Another Rmb200bn of the liquidity injection is intended for SME credit supply. The share of SME credit in bank lending has been declining since 4Q17, which was partially driven by the ongoing credit market volatility―rapidly rising bond yields have pushed more SOEs to resort to bank loans and “squeeze” out the credit quota for SMEs. The move closely followed the State Council meeting on June 20, which emphasized the urgency of increasing credit supply for the SMEs.

The RRR cut was largely within the market’s and our expectations. We see more room for policy adjustment going forward. Although the magnitude of the RRR cut appears less generous than the previous cut (50bp this time vs. 100bp last time), the actual effect may be similar since part of the liquidity released from the last 100bp “targeted” cut (900bn out of 1.3 trillion) was supposedly used to swap out MLF outstanding as they mature. We have seen early signs of policy adjustment lately, with the PBoC not following the US in hiking OMO rates last week, while the central bank has also stepped up its OMO net injection visibly. It is worth noting that the PBoC has net-injected Rmb680bn worth of liquidity via OMO in the past two weeks, compared with Rmb83bn same time last year. In our view, the current policy adjustment is much needed to offset the visible tightening effect from overlapping policy tightening since November last year. More specifically in regards to monetary policy, the new asset management industry guideline and the tightening over non-standardized credit issuance has created a considerable “funding gap,” evident in the much-faster-than-expected decline in the adjusted TSF growth. More recently, the credit bond market volatility has added to the tightening pressure as new issuance ground to a halt. Since the regulatory tightening measures continue to hinder credit creation, we expect more efforts from the central bank to adjust the policy setting and revert to a more “neutral” stance in order to prevent corporate and government cash flow from worsening too quickly. More specifically, we expect 150bp more in RRR cuts for the remainder of the year (“targeted” or not), expansion of the bank loan quota, replenishment of banks’ capital (esp. for the smaller banks), as well as publication of more detailed and pragmatic guidelines in regards to the timeline of financial deleveraging (potentially folded into the detailed sector-level rules for the new asset management industry guidelines).