February 21, 2012 / 5:49 PM / 5 years ago

Analysis: China bid to boost growth a surprise in timing only

7 Min Read

BEIJING (Reuters) - Any surprise at the timing of China's move this weekend to spur bank lending may be misplaced. Instead, investors should recognize that China is determined to engineer a soft landing for the world's second-biggest economy.

Premier Wen Jiabao had flagged that Beijing should "act quickly" following January economic data that analysts said pointed to additional economic weakness beyond what could be explained by Lunar New Year distortions.

Still, many investors had not expected a cut in bank reserve ratios until March, so the timing of the decision late on Saturday announcing the second 50-basis point cut in bank reserves in three months took them by surprise. The timing may have been geared more to showing that Beijing -- not financial markets -- determine policy.

"The immediate market reaction is surprise on the timing, but people were looking for an RRR cut -- it was just a question of when," said Tim Condon, head of research at ING in Singapore.

"They don't want the market to push them around."

The cut in the RRR -- the reserve requirement ratio -- was China's latest move to support an economy that is widely seen slowing down this quarter for its fifth consecutive quarter. Economists expect full-year 2012 growth to slip below 9 percent for the first time in a decade.

Many economists had thought a cut would come just ahead of January's Chinese Lunar New Year holidays.

When it failed to materialize, they shifted their expectations to March, thinking policymakers would rather make a decision once they had the combined data releases of January and February to smooth out Lunar New Year distortions.

They were further taken aback because the People's Bank of China had reportedly injected liquidity into the financial system via reverse repos on Friday -- a mechanism that analysts said the central bank had been using in the early weeks of 2012 precisely to avoid the need for a cut to the RRR.

For these various reasons, the central bank knew a cut in bank reserves now could surprise. So at least making the move public on Saturday would give investors time to absorb the news before markets opened on Monday.

The persistent wrong-footing of financial markets on major policy shifts, rather than guiding expectations as major Western central banks do, has been a hallmark of Chinese policymaking since the landmark yuan revaluation in July 2005.

One explanation is that PBOC lacks operational independence. It formulates new monetary policies but has to wait until the State Council -- China's cabinet -- gives it the green light.

On Easing Path

The 50 basis point cut in the RRR to 20.5 percent releases about 400 billion yuan ($63 billion) that could be used for bank lending.

The move buoyed international markets on hopes the money would be poured into infrastructure projects and boost demand for commodities.

Chinese traders were more cautious, reflecting the view that Beijing is far from loosening monetary policy outright.

That's because Chinese policymakers fear re-igniting inflation and real estate speculation, which are just coming under control after a 4 trillion yuan ($635 billion) government stimulus package during the 2008/09 global financial crisis sparked a borrowing frenzy.

"The fact that they chose the RRR shows the government wishes to send a clear signal to the market that they do not wish to make policy tight," Yu Song, China economist at Goldman Sachs, said in a report.

"This is consistent with Premier Wen's comment around a week ago that new orders have been falling in January and policy fine tuning will start in the first quarter of 2012."

In remarks published by state media on Feb 13, Wen flagged fresh measures to support the economy.

"We should see things early and act quickly," he said. "Pre-emptive steps and fine-tuning needs to start from the first quarter.

Data released this month showed spluttering domestic demand as imports fell in January the most in more than two years and weaker-than-forecast bank lending signaled Beijing would make a fresh bid to bolster economic activity.

Growth is widely expected to slow to just over 8 percent in the first quarter of 2012 from 8.9 percent in the previous quarter, as exports lose steam and government measures cool the property market.

Economists Reuters spoke to since the latest cut in bank reserves said they were sticking with their forecasts for further easing this year. A Reuters poll conducted last month showed economists expect a total of 200 basis points of RRR cuts throughout 2012 to 19 percent.

The central bank may also use open market operations to ease liquidity strains and authorities may relax curbs on the loan-to-deposit ratio requirement so banks can step up lending, analysts say.

Few expect the central bank to cut interest rates though while inflation remains stubbornly above the one-year deposit rate of 3.5 percent for fear it could spark a rush of cash out of deposits and into more speculative investments.

The central bank faces limited options but to reduce bank reserve requirements further to help counter expected capital outflows. Data showed China experienced capital outflows in October, November and December and only a small inflow in January.

Outflows strain the economy's ability to generate enough money supply to support economic growth, analysts say.

"We believe the tight liquidity in the interbank market and significant rise in interbank interest rates prompted the cut, which should not be viewed as signaling a change in monetary policy stance," Tao Wang, China economist at UBS in Hong Kong, said in a note to clients.

"We maintain that the timing and number of RRR cuts will depend on liquidity conditions, especially the timing and amount of net FX inflows."

Analysts also point to a fall in bank deposits -- caused by a frenzy among Chinese to buy higher-yielding wealth management products -- as an added strain on bank lending capacity.

Zhou Hao, an economist at ANZ in Shanghai, suspected bank lending growth so far in February was depressed, following lower-than-expected news loans in January.

The central bank, which is more concerned about inflation than other factions of the government, faces some criticism that it has been moving too slowly on policy loosening. A continued mismatch between market expectations and changes in policy carries risks.

"I think the central bank still puts too much emphasis on inflation. It has repeatedly defied market expectations rather than move in line with expectations," said Wang Jun, an economist at CCIEE, a top government think-tank in Beijing.

"It has not done enough to fine tune policy. If this continues, it's difficult to achieve the goal of stabilizing growth."

Reporting by Kevin Yao; Editing by Neil Fullick

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