The decision by the People’s Bank of China to lower the reserve requirement ratio (RRR) by 100 basis points for the whole banking sector has been greeted as “an aggressive new attempt to combat a slowing economy”.
However explaining the move simply by reference to a fixation on raw percentage GDP increases is inadequate.
For one, the move is potentially aimed as a blow against shadow banking. The sheer size of private funds involved in the largely unregulated shadow banking sector poses significant risks to the financial system overall.
For example, financing through the shadow banking system in Zhe Jiang Province alone constituted 58% of total investment in fixed assets in 2008. While small business contributed to more than 60% of national GDP in 2009, only 22.2% of all corporate lending by banking institutions was extended to small business at the same financial year. The change will certainly make the sector comparatively less attractive for borrowers.
Also, the change must be seen in the context of reining in stimulus policies that were put in place in response to the global financial crisis of 2008-2009, particularly local governments borrowing through the Local Government Funding Platform scheme.
This caused a major headache for the central government. By the end of 2009, the debt outstanding under the scheme against some local governments had ballooned to approximately 400% of local GDP. Earlier this year, the government ordered local governments to convert bank loans into government bonds. In turn, this improved the asset quality of the banks, and this can been seen as under-pinning the reduction of the RRR. At the same time, further money-raising through the scheme has been prohibited.
But fears of a Chinese stock market bubble as a result of the easing are not unrealistic. One might argue that this is already the case. However, it’s not clear how much this really matters in an economy where securities markets and government/corporate bond markets remain undeveloped as funding sources for business, and whether the risk is offset by directing investor attention to the exploitation of these devices.
The stock of total domestic securities in China currently is about 45% of GDP. In comparison, in the US, it is about 160% of GDP. Ordinary investors and the government instrumentalities are all being encouraged to access the securities markets. For example, on 12 April, the China Securities Registration Company announced the abolition of the “one person and one account” policy in relation to the securities markets. Individuals is now allowed to hold up to 20 accounts. The move allows individuals to trade stock more freely and enables them to trade through multiple intermediaries.
On the other hand, the government has also tightened controls on margin lending. So one should not assume that easier credit will automatically flow freely into the secondary stock market.
In short the reduction in the RRR should not be seen in isolation. The Chinese economy remains highly government-directed, and the government has available to it a great many more controls than pushing and pulling on the fiscal and monetary levers. This move is one of a number of co-ordinated actions by the central government and the picture is more complicated than the implementation of a simple general monetary loosening as per a western free market economic model.
What is being aimed at is probably not merely short-term expansion, but the use of a device to aid in a change in the financial market “mix” of the economy in a way that the government sees as conducive to longer term development.