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November 24, 2011

China Cuts RRR for Selected Rural Banks and Its Evolving Reserve Requirement

By Central Bank News

The People's Bank of China reduced the required reserve ratio for selected rural cooperative banks by 50 basis points to 16.00% from 16.50% according to FT/Bloomberg. The move heralds a possible turn in policy settings in China, and follows previous comments from Chinese Premier, Wen Jiabao, that the Chinese government would "preemptively fine-tune policy at a suitable time and by an appropriate degree".

The move also follows an apparent peak in inflation in China of an annual rate of 6.5% in July this year, dropping to 5.5% in October. The move also coincided with the release of the preliminary HSBC/Markit PMI which dropped to 48 in November, from 51 in October; also showing weakness in input and output prices, and new orders.

The People's Bank of China last raised the reserve requirements by 50 basis points in June this year to an average 21.50% for large banks, and 19.50% for small banks. The PBC also adjusted the reserve requirement rules in August, effectively resulting in tightening of about 100bps. Meanwhile the People's Bank of China last raised the benchmark interest rate 25bps to 6.56% in early July this year. 

The Bank for International Settlements recently published a paper on 'China's Evolving Reserve Requirements' which provides an interesting and detailed analysis of the People's Bank of China's use of the required reserve ratio as a tool for monetary policy.

The paper focuses on China's use of the Required Reserve Ratio (RRR) as a key tool in monetary policy in a number of capacities. The paper identifies that the RRR has been used as a multi-purpose tool by the People's Bank of China for purposes such as sterilising foreign exchange intervention, influencing credit growth, influencing interest rates, and more broadly as a means of signalling the monetary policy stance (e.g. stimulus or tightening).

The authors point out that while the RRR is at historical highs, it could remain at relatively high levels in the medium term, notwithstanding an apparent peak in the RRR. Indeed the authors note:
"the outlook for higher reserve requirements may also relate to policy stances of major economies. Given the prospects of an extremely easy policy stance in most major economies for an extended period of time, the possibility of a continued preference for this sterilisation tool over others should not be discounted.  Overall, China’s reserve requirement ratio appears to be peaking in the current tightening cycle."

The paper provides a timely insight into one of the key monetary policy tools (along with interest rates) used by what is now the world's largest economy. Indeed, there is much discussion around when China will begin to turn its policy settings from tightening to easing as inflation in China shows signs of moderating, and global growth concerns paired with various other risks in China e.g. a weakening property market, and recent rapid loan growth, present downside risk to the growth and inflation outlook.

Ma, G., Xiandong, Y., & Xi, L. (2011) China's Evolving Reserve Requirements. BIS Working Paper No. 360

About The AuthorCentral Bank News is dedicated to provide timely, and comprehensive global central banks news and policy developments (EconMatters author archive here.)

The views and opinions expressed herein are the author's own, and do not necessarily reflect those of EconMatters.

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