China Economic Update: October 2017

Repurposing an old tool – a new life for the Required Reserve Ratio.

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Overview:

  • Since it adopted a more modern approach to monetary policy in late 2015, it looked like the People’s Bank of China had little use for its older policy tools – such as the benchmark lending rate and required reserve ratio (RRR). The latter had remained unchanged since February 2016, but was repurposed at the end of September – with a goal of boosting lending to China’s financially neglected small business sector.
  • One of the key challenges facing smaller firms in China is access to finance. Large state-owned banks have always preferred to lend to large state-owned enterprises (SOEs), due to long standing relationships and strong political connections. According to the IMF, SOEs account for over half of China’s total corporate debt but less than 20% of industrial value added.
  • At the end of September 2017, the PBoC unexpectedly announced a cut to the RRR. This policy change differed significantly from previous occurrences. First, the change isn’t scheduled to occur until 2018, meaning that banks have plenty of time to prepare. Secondly, it consists of two distinct cuts, with different eligibility requirements depending on the banks’ end of 2017 balance sheets. While most banks will be eligible for the smaller cut, far fewer banks currently meet the threshold for the larger one. That said, they have almost three months to adjust – meaning there is a profitable incentive to rapidly expand lending to small business over this period.
  • At a high level, the repurposing of the RRR is a positive move – providing banks with a direct incentive to improve access to finance for an under-represented section of Chinese business. That said, it will be some time before we see how successful this change will be. For example, it is unclear whether this measure is a one off, or if future incentives will be offered (given that the RRR remains comparatively high). Similarly, it is unclear if banks will expand lending up to the threshold requirement, or will continue past this level. As has been seen with other reforms in recent years, achieving long term change can be difficult

For further details, please see the attached document: