The unexpected consequences of China’s crackdown on shadow banking

In early February 2015, the People’s Bank of China (PBoC) cut the Reserve Requirement Ratio by 50 basis points. This was the first broad based cut to the RRR since May 2012 and it could release around RMB 612 billion in liquidity.

The PBoC was quick to downplay the significance of this change, arguing that the move was a response to the recent tightening in liquidity conditions and that the cut was not expected to be stimulatory. There is some basis for this argument, given the substantial outflow of capital from China in recent quarters – in part an unexpected consequence of the recent crackdown on shadow banking (which may have reached 100% of GDP in mid-2014).

Between April and December 2014, there was an estimated net outflow of US$214 billion, with speculation that this represents ‘hot money’ leaving the country as the carry trade unwinds.

Further cuts to the RRR may be necessary in 2015 simply to keep financial markets liquid and functioning – vitally important to the large number of firms in China who roll over debt to continue operations.

For further details, please see the attached document:

• China Economic Update – 18 March 2015