China bids to offset capital outflows

THE Chinese central bank has effectively freed up to 600 billion yuan ($123bn) worth of liquidity in the economy.

THE Chinese central bank has effectively freed up to 600 billion yuan ($123bn) worth of liquidity in the economy after ordering the first banking sector-wide Reserve Requirement Ratio in almost three years in a bid to reverse growing capital outflows and kick-start the flatlining national property market.

The decision was ordered late Wednesday night and propelled some regional Asian equities markets higher as investors bet the People’s Bank of China could be forced to move again in the next few months.

Macquarie economists forecast it could cut the RRR, which is not the official cash rate but the level of deposits banks must hold, four more times in 2015 and up to 20 times over the next few years.

The decision to reduce the rate by 50 basis points takes the RRR for major banks to 19.5 per cent and 17.5 per cent for smaller banks.

The PBoC also revealed that the Agricultural Development Bank’s rate would be cut by 400 basis points, in a clear indication that authorities are concerned about the agricultural sector.

Dairy farmers in China have been hard hit by the global dairy price slump over the past year and have reportedly killed cows and been forced to dump milk.

The PBoC’s decision was the first move for the whole banking sector since May 2012, but it did cut the RRR for small and provincial banks a number of times last year to help spur lending. Economists believe the ongoing property market weakness, especially in second and third tier cities, and the risk of deflation were the reasons for the PBoC to act now.

There had been speculation the central bank would cut the rate before Chinese New Year, which falls in the middle of this month, because there is a traditional drain on the financial system during the 10-day festival.

However, it was revealed this week China suffered the biggest outflow of capital during the fourth quarter since 1998.

Macquarie analyst Larry Hu said the PBoC was likely to cut the RRR again rapidly to help offset the capital outflows.

The RRR was raised 19 times between 2006 and 2008 and 12 times between 2010 and 2012.

“During the go-go years of global imbalances a huge amount of money flew into China,” Mr Hu said.

“Given the muted capital inflows in recent years the course is reversing now.

“ In the next five years we believe there would be at least 20 RRR cuts and the rate will be lowered to around 10 per cent.

“From a structural point of view, it’s a shame that the RRR cuts are seen by some as politically incorrect, an indicator of turning on the monetary taps,” Mr Hu said.

“In our view, it is just a normal monetary policy tool which should be lowered on falling capital rates.”