The PBoC announced another “not-so-targeted” 100bp RRR cut, effective on October 15. According to the Q&A published on the central bank’s website, the cut aims to replace Rmb450bn of MLF maturing on Oct. 15, while releasing Rmb750bn to offset the liquidity-drain from tax submission in 2H October1. Right before market re-opens after the Golden Week Long Holiday, the PBoC announced on website that it will lower the reserve requirement ratio (RRR) by 100bp for large state-owned banks, share-holding banks, urban commercial banks, foreign banks, as well as above-county-level commercial bank – i.e. most of the deposit-taking banks. This is the fifth time the central bank has conducted RRR cuts in various forms since September last year, the previous cuts included the targeted RRR cut announced on September 30, 20172, the Contingent RRR Arrangement (CRA) over the Lunar New Year of 20183, “targeted” RRR cut partially to replace maturing MLF announced in April 20184, and the RRR reduction to facilitate debt-to-equity swap and SME loan issuance in late-June5. In the Q&A on the PBoC website, the central bank revealed that the total amount of liquidity released from this RRR cut will likely amount to Rmb1.2trillion, relatively close to the amount from a full 100bp RRR cut (which would be estimated at ~Rmb1.5trillion). While Rmb450bn was designated to replace maturing MLF on October 15, the rest aims to release liquidity ahead of the tax-submission–induced “crunch” in 2H October.

Another RRR cut, which came in only 3 months after the last one, sends a clear signal that the central bank is determined to keep liquidity conditions accommodative. However, its actual impact on overall liquidity conditions and broad money supply hinges on the “execution”. The central bank has shifted towards a more accommodative and pragmatic stance since June 2018, signified by a series of policy moves in this direction and a sharp decline of the short-term interest rates (Figure 1)6. In this context, the RRR cut came in “just in time” as worries over trade tension escalated and growth momentum softened more recently. However, the eventual net impact on liquidity is not a straight-forward calculation, given the fact that there is Rmb9.26trillion of OMO instruments outstanding, >600bn of which matures in October (Figure 2). Furthermore, fiscal deposits jumped by Rmb1.05 trillion last October amidst tax-submission season, directly depressing base money growth – in other words, the net impact of this RRR cut depends on how much the central banks injects/withdraws via OMO, as theoretically, the liquidity drain from tax submission alone exceeds the amount of Rmb750bn liquidity injection (, which aims to offset the “crunch”).

Removing the “blockage” of monetary policy transmission, esp. through more accommodative fiscal policy setting, will greatly enhance the positive impact on growth from stabilized financing conditions. As we have discussed in our recent thematic report , while looser liquidity conditions help stabilize market expectation and growth momentum to some extent, there are a few impediments in the policy transmission that may result in delay and discount the effectiveness of momentary policy conduct. Among the few “blockage” we listed, one of the common denominators is the “de facto” tightening of fiscal policy. It is worth noting that effective tax rate has risen, while centralized collection for social security contribution may add to the corporate quasi-tax-burden. On the other hand, slower fiscal fund dispersion led to rising fiscal surplus year-to-date, while tightened infrastructure project approval and financing also dampened investment growth. Therefore, it is crucial for fiscal policy to become more supportive to growth and corporate profitability before monetary policy can become more effective.

Over the medium-long term, it is worth reiterating that lower RRR, coupled with slower growth of central bank relending or the base money is a welcomed structural development. The move signifies the PBoC’s effort to move from “quantity-based” policy conduct to a more “price-based” (and transparent) one. It is encouraging to see that along with the adjustment towards a lower “de-facto” RRR, growth of the base money and PBoC relending outstanding has slowed visibly since 2H17 (Figure 3). We reiterate our long term view that Chinese banks required reserve ratio will likely “normalize” and settle at a lower level, since the elevated official RRR has increased the opportunity cost for banks and incentivize them for “regulatory arbitrage”. Lower RRR is in line with the long term goal of financial deleveraging, as it reduces the incentive for the banks to resort to shadow-banking activities. Furthermore, replacing central bank relending with RRR cut is also a welcomed structural “re-balancing”, as it reduces the transaction cost of keeping a large stock (Rmb9.3trillion) of relending instruments and carrying out daily open market operations (OMO). Over the long term, the relative size of China’s base money to GDP ratio have room to decline further, as it is still proportionally larger (vs. GDP) compared with other major economies (except Japan).

On the FX front, the signaling effect of the RRR cut could be marginally unfavorable to the CNY exchange rate in the very short term. However, the strength of the currency is ultimately determined by the growth momentum. Meanwhile, we do not expect a “collapse” of CNY/USD. On the other hand, CNY may drift a tad lower vs. the basket in the near term. Granted, the narrowed China-US short-term rate differentials and the RRR cut may be moderately negative for the CNY/USD exchange rate. However, economic fundamentals and investment returns remain the dominant determinant of CNY demand and CNY exchange rate. In the near term, we see little room for the CNY to appreciate vs. the USD or the currency basket, as the “turning points” of the CNY exchange rate usually lags that of the turn of economic fundamentals (proxy-ed by China’s nominal growth or corporate profit growth). However, we see the near term “downside” for CNY/USD to be limited as well, given our more benign view on the USD trajectory over the medium term . All considered, CNY may remain on the soft side vs. the currency basket in the near term. It is worth noting that this time round, there have been no clear signs of FX outflow despite rapid depreciation of the CNY since June , which points to incrementally loosening of the financial conditions and some “buffer” amidst rising external demand uncertainties.