100bp RRR cut to replace maturing MLF & release liquidity
2019/01/07

  The PBoC kicked off the first week of the year by a broad-based RRR cut of 100bp, 50bp of which will become effective on January 15, while the rest will be executed on January 25. The announcement was posted on the Central Bank’s website shortly after market close today, following Premier Li Keqiang’s remarks earlier in the day indicating that a “broad-based RRR cuts” is on the way. Although this is the sixth RRR cut in this round, it is the first time it was announced without the prefix of “targeted” (cut) since February 2016. Prior to today’s announcement, the central bank has conducted targeted RRR cut on September 30, 2017, the Contingent RRR Arrangement (CRA) over the Lunar New Year of 2018, “targeted” RRR cut partially to replace maturing MLF announced in April 2018, the RRR reduction to facilitate debt-to-equity swap and SME loan issuance in late-June, and the “targeted” RRR cut to boost inclusive financing and replace MLF. By the end of January 2019, the RRR ratio would have been reduced by a total of 4-5ppt (depending on the bank) since 2018.

  According to the Central Bank’s press release, “net” liquidity release from this RRR cut will amount to Rmb 800bn. Although there is still considerable flexibility in monetary policy conduct which may add to or subtract from the actual amount of liquidity release, the gesture points to a more accommodative stance of the PBoC. The central bank also stated that all the maturing MLF in 1Q will no longer be rolled over, which actually amounts to Rmb 1.2 trillion. However, since we estimate that a broad-based RRR cut will release ~Rmb 1.5 trillion of liquidity in total, it is likely for the PBoC to inject liquidity via other forms of relending in 1Q, including the newly introduced TMLF. However, it is worth noting that the outstanding MLF stock has grown by a cumulative Rmb 900bn since the PBoC started to conduct RRR-MLF swap in April 2018. By contrast, the combined amount of MLF swapped/replaced from the cuts in April & October 2018 should have amount to Rmb 1.35 trillion. This simple analysis highlights the flexibility of monetary conduct where the actual amount of liquidity injection may vary from the announced number, nevertheless, a broad-based RRR cut announced less than 3 months since the last one still points to a more accommodative monetary policy stance.

  The RRR cut aims to provide liquidity support for the real economy as both domestic and external demand growth has deteriorated rapidly. In addition, the RRR cut also serves to (partially) bridge the liquidity gap ahead of the Lunar New Year (LNY) long holiday. China’s manufacturing PMI dipped below the 50 inflection point in December and printed the lowest level since March 2016 at 49.4%. Domestic demand growth has been decelerating visibly on multiple fronts, including discretionary consumption, property demand and investment, as well as mfg. capex. In addition, external demand growth has been falling quickly, driven by the double whammy of a downturn in global industrial cycle, and the “withdrawal symptom” from the “front-loading” effect before additional US tariff on China exports took effect. Meanwhile, there is typically a >1 trillion Rmb liquidity gap before the LNY, which was quoted as one of the reasons behind the timing of the RRR cut.

  Looking forward, we expect 100-200bp more RRR cuts throughout the course of 2019, and downward adjustments of the open market operation (OMO) rates. In addition, we do not rule out the possibility of another Contingent RRR arrangement (CRA) ahead of LNY in spite of this cut. We reiterate that against the backdrop of falling credit demand, tightened financial regulations, and daunting fiscal funding gap, the PBoC will likely continue cutting RRR, and potentially lower OMO to facilitate a large amount of government bond issuance this year. In addition, with corporate investment returns falling and inflationary impulse receding, effective lending rate and risk free rate will also likely decline. However, given the still-restrictive demand-side policies and regulatory environment, we will gauge the effectiveness of these liquidity injections by monitoring the sequential growth of adjusted TSF. In our view, the transmission of monetary policy loosening will likely remain impaired without prompt adjustments to policies that are choking property demand, local government financing, and the credit cycle expansion. In our view, the most comprehensive indicator to assess the effectiveness of the growth stabilization efforts is still adjusted TSF growth – a notable and sustained pick up in adjusted TSF growth points to potential recovery of aggregate demand growth.