PBOC continues to roll-back restrictive policies of the last few years.

China's PBOC has been very active over the last six months, using every tool in the toolbox (See infographic page for information on PBOC tools).  The recent stepped-up PBOC activity and easing is not a shift back to the easy money policies of the late 2000s, but instead is a normalization from very restrictive policies starting in the early 2010s to rein-in the excesses of the post-crisis surge in debt and overcapacity.  As the chart below shows (as well as a dramatic slowdown in outstanding credit growth, seen on my debt chart and table page), rates are relatively high vs. inflation.

The most important tool to watch is the reserve requirement ratio (RRR), and here is why:

  • Many PBOC activities are being employed to minimize rate volatility and reduce liquidity distortions.  China does not have an overnight target rate, like the Fed and ECB, resulting in short-term rates driven mostly by market forces and seasonal disruptions (for example, during Chinese New Year huge numbers of depositors take money out of the banks for gifting, and that cash then returns to the banking system sometime after.  This causes seasonal volatility in rate markets). China's short-term interest rate volatility has been nearly 50 times the rate volatility in the US and 10 times South Korea over the last 5 years.  Direct lending through the SLF and MLF (again, see infofraphics for details) are tools created to limit volatility and disruptions, in a restrictive monetary environment in particular.  These tools are not intended to stimulate broad growth prospects, as their tenors are relatively short-term and therefore meant to manage temporary disruptions in liquidity and before the cash is given back to the PBOC.
  • Lowering the deposit and lending rates are much less effective than they once were.  The mandated lower limit lending rate was already removed for all but property loans. Lending rates are technically set by the markets.  And as deposit rates are lowered, the ceiling for the deposit rate has remained the same because the allowable range above the mandated benchmark rate was increased.  Deposit rates haven't technically been mandated lower.  Private banks can keep deposit rates unchanged, as state-owned banks probably feel obliged to lower them.  Changes to the benchmark lending rates are more about laying the groundwork for rate liberalization & making private banks more competitive than stimulating broad growth.  We are 5 months removed from the first benchmark rate cut, and economic activity has been unfazed.  Lowering benchmark rates will have some stimulative effect, but as rate liberalization takes place the effect is uncertain.
  • Lowering the RRR releases funds for lending potentially for many years to come.  Coupled with expansion of the budget announced in March, we should see a meaningful stimulus to broad growth from RRR cuts.  As far as the PBOC toolbox goes, the direct lending facilities are like a chisel, meant to smooth.  Benchmark rate cuts are like a mallet, meant for specific tasks, but nowadays less useful for big jobs.  The RRR (as long as there is stimulus on the demand side) is like a sledgehammer, heavy enough to get the job done.