Fitch: China's 100bp RRR Cut Marks a Step-Up In Monetary Easing

The People's Bank of China's (PBOC) 100bp cut to the reserve requirement ratio (RRR), effective on 20 April, marks a step-up in monetary easing from earlier policy measures, says Fitch Ratings. Fitch estimates that the cut will release CNY1.5trn (USD240bn) in liquidity, lowering borrowing costs and alleviating debt-servicing burdens for corporates, state-owned enterprises and local governments. For banks, the cut will have a moderately positive effect on net interest margins and earnings.

 The decision suggests a more aggressive approach to monetary policy easing by the PBOC compared with the targeted measures in 2014 which focused on lowering borrowing costs only in selected sectors. It also goes beyond replacing liquidity lost through recent capital outflows. By contrast, a previous 50bp RRR reduction on 5 February only compensated for cross-border capital outflows during 2014 (see Fitch: China's RRR Cut Less of an Easing Than it Appears, 5 February 2015).

 The move is not surprising, considering the recently released 1Q15 economic data which showed real GDP growth slowing to 7%. The slowdown is part of a broader macroeconomic structural adjustment away from debt-driven investment growth and rebalancing towards domestic consumption. Fitch expects economic growth to slow further, with real GDP likely expanding by only 6.8% this year. This is a significant deceleration from the 10.5% average annual growth recorded in the 2001-2010 period.

 Fitch's base case is that this economic adjustment will have positive long-term effects on stability by putting the economy on a more sustainable growth path. Furthermore, the agency maintains that the Chinese authorities have the capacity to manage this adjustment - through monetary and fiscal policy - without resulting in significant financial or economic instability. However, there are risks that the rebalancing will not play out smoothly.

 Monetary easing through a broad-based RRR cut will allow banks to reinvest the liquidity released from the central bank. This should alleviate some of the pressures on net interest margins (NIM) in 2015 which have been squeezed as a result of earlier rate cuts and an increase in the deposit rate ceiling. However, NIMs are still likely to contract this year, and the overall earnings impact will not be significant - likely to rise by 1%-2% as a result of the RRR cut.

The RRR cut will also help banks continue the trend to shift credit back on to the balance sheet. Bank loans represented 78% of total new total social financing in 1Q15, up from 60% in 4Q14. Additional bank loans enabled by the RRR cut will allow more debt to be rolled over, though it will only delay and not resolve a rise in NPLs over the medium term.

But there are still risks should banks utilise this RRR cut (and any future cuts) to revert to excessive loan growth, despite the positive short-term effects for banks. Fitch maintains that a reversion to broad-based, rapid lending growth would be credit negative for banks, in light of leverage in the system which is already high.