A Look at the PBoC’s Surprise RRR Cut

ANBOUND
6 min readMar 21, 2023

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On March 17, the People’s Bank of China (PBoC) announced that from March 27, it will reduce the reserve requirement ratio (RRR) for financial institutions by 0.25 percentage points (excluding financial institutions with a 5% reserve ratio already in effect). After this reduction, the weighted average RRR for financial institutions will be around 7.6%. The Chinese central bank stated that it will implement a precise and forceful prudent monetary policy, better leverage the dual functions of quantity and structure of monetary policy tools, maintain moderate and stable growth of monetary credit, ensure reasonable and adequate liquidity, match the growth rate of money supply and social financing scale with the nominal economic growth rate, better support key areas and weak links, avoid flooding the market with excessive liquidity, balance internal and external considerations, and strive to promote high-quality economic development.

The Chinese central bank stated that it will implement a precise and forceful prudent monetary policy, aiming to better leverage the dual functions of quantity and structure of monetary policy tools. This, according to the PBoC, is also to maintain moderate and stable growth of monetary credit and ensure reasonable and adequate liquidity. In addition, this is to match the growth rate of the money supply and social financing scale with the nominal economic growth rate. The objective of this is to help support key areas and weak links while avoiding flooding the market with excessive liquidity.

In terms of direct impact, this adjustment is expected to release approximately RMB 500 billion of long-term liquidity into the market. Some institutions predict that it will reduce financing costs by approximately RMB 7 billion. Such a comprehensive RRR cut reflects the central bank’s policy of “precise regulation”.

Most market institutions appeared to be surprised by the RRR cut. The timing, control of liquidity injection, and implementation method all caught them off-guard. Data released earlier showed an increase in overall social financing, credit scale, and monetary issuance growth rates in the first two months of the year. Consumption and investment data during the same period also indicated a gradual recovery of the macroeconomy from the pandemic’s impact. Therefore, there was no urgent need to support the real economy through monetary policy. Furthermore, the PBoC had already expanded the scale of open market operations several times. This week, there was not only an increase in the size of reverse repurchase agreements but in the size of MLF operations, resulting in a net liquidity injection of approximately RMB 700 billion for the week. Meanwhile, unlike the previous policy warning issued through a State Council meeting, this reserve requirement ratio cut did not have a clear policy warning. Therefore, this comprehensive cut was indeed a “surprise” for the market.

The role of the comprehensive reserve requirement ratio cut in the capital market and the real economy lies in the release of long-term funds to ease the economy. As the PBoC has repeatedly emphasized, this is not a comprehensive and loose massive easing policy, but more about releasing liquidity to meet the monetary demand brought by economic growth. In fact, researchers at ANBOUND have mentioned this exact point several times before. In recent years, with China’s stable economic growth and foreign exchange reserves, its central bank can only adjust the basic monetary supply through reserve requirement ratio cuts and open market operations. Therefore, the role of RRR cuts in guiding policy loosening has gradually weakened, and it is more reflected in supporting the incremental demand for money brought by the economy. In this context, it is still possible to implement a comprehensive RRR cut policy in the future to continuously release long-term funds into the market and increase the liquidity of the monetary supply.

According to researchers at ANBOUND, the unexpected RRR cut is aimed at maintaining overall market liquidity stability judging from this year’s situation. This is particularly important after the surge in credit during the first two months, as the Chinese central bank considers the sustainability of market liquidity to avoid the disruptions of credit and social financing that troubled the market last year. To maintain a certain level of monetary and social financing growth rate, continuous injection of liquidity is necessary. With the strong expansion of bank credit during the first two months, the demand for money has also increased. In this context, it is necessary for the PBoC to not only expand short-term liquidity but also release long-term liquidity through RRR cuts to foster market confidence and stability.

For a period of time, market interest rates have indeed shown signs of continuing to rise, indicating that banks and other financial institutions need to replenish funds after the credit scale has expanded significantly. At the same time, in order to achieve a balanced recovery after major reverse repos, the PBoC also needs to consider the replacement of long-term funds to avoid a cliff-like shortage of market funds or a short-term liquidity “snowball”. From the perspective of economic operation, the current economic recovery in China is not sufficiently stable, and there is a need to continue to increase monetary support. In particular, the overall level of inflation within the country continues to fall, reflecting weak demand, and the real economy still needs support from monetary expansion.

At the same time, with difficulties and crises in the external banking industry triggered by the collapse of Silicon Valley Bank, the Chinese market provides sufficient liquidity to avoid increased liquidity risks in its domestic banks, which is also to prevent financial risks and the need to isolate external shocks. Due to the interference of the banking crisis, the central banks of major economies such as the Federal Reserve are expected to slow down the pace of continuous interest rate hikes, bringing some new policy space for the release of liquidity in China.

Regarding future policy operation trends such as RRR cuts and interest rate cuts, PBoC governor Yi Gang noted that the current level of some major variables of the Chinese monetary policy and the level of real interest rates are appropriate. He stated that while the statutory deposit reserve ratio is not as high as in the past, it is still a relatively effective way to provide long-term liquidity and support the real economy by reducing the reserve ratio so that the overall liquidity can be maintained at a reasonable level. This attitude means that there is not much room for interest rate cuts, and the RRR cut is still very feasible as an aggregate tool. The PBoC can certainly still use structural tools to achieve the goal of promoting economic structural reform and realizing the expansion of total money.

It needs to be pointed out that even though the RRR cut will still be promoted this year, it is to prevent a sharp decline in the economy, as well as to increase liquidity in the market, rather than completely stimulating demand. Although the central bank’s monetary policy has been unexpected by many, the general direction has not deviated from the sound policy tone of focusing on stability.

Final analysis conclusion:

The People’s Bank of China has recently announced that it will reduce the deposit reserve ratio of financial institutions by 0.25 percentage points on March 27. This comprehensive RRR cut has indeed surprised the market, reflecting that the recovery of the real economy remains unstable, and monetary policy support is still needed. At the same time, after the “good start” of credit in the first two months, maintaining the growth rate of money and social financing above a certain level requires a continuous injection of liquidity. Therefore, this measure still plays the role of preventing the decline of the economy and injecting liquidity into the market.

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ANBOUND

ANBOUND is a multinational independent think tank, specializing in public policy research, incl. economy, urban and industry, geopolitical issues. Est. 1993.