Despite the fact that People’s Bank of China has not eased policy in the traditional way since it last cut interest rates, it should be noted that the PBOC has tried a lot.
The market has been hoping for a Reserve Ratio Requirement cut every weekend, only to be disappointed every week. However, the PBOC has been trying to ease liquidity repeatedly through open market operations, tools that were not the focus.
In the past 14 weeks (or about 3 months), PBOC has made about RMB1.031 trillion of net injection into the system. With China’s total deposit base close to RMB90 trillion, the liquidity being made available for the past 14 weeks is roughly equivalent to 2 regular reductions of reserve requirement ratios (RRR), 50bps each.
Of course, communication is one of the greatest tools central banks have, and one can argue that the message conveyed by a reduction in RRR is much more aggressive as a reduction of RRR cut could be viewed as a somewhat more “permanent” than repeatedly conducting short-term reverse repo. Reductions in RRR perhaps convey a message that the PBOC is determined to ease, while repeated reverse repo convey a message that PBOC is so very determined at all.
That, of course, happens to be the message I am reading, which is consistent to the view that the Chinese central bank and government will be slow to ease monetary policy given all the concern over the real estate market, as well as the view that the massive stimulus of 2008/09 was a great mistake.
Still, one cannot escape the fact that PBOC has actually injected a lot of money into the system. Although reverse repo injections are somewhat more low-profile relative to cutting RRR, total net injection for the past 14 weeks (this week included) is about equivalent to 2 RRR cuts, 50bps each:
Unfortunately, despite all these aggressive injections, the Chinese banking system continues to suffer from a liquidity crunch every few weeks. Also, quite remarkably, interbank rates are no lower than they were before the first rates cut, as the chart below shows (with the arrows pointing to the dates of recent rate cuts”):
So it is fair to say that the PBOC has done a lot, but not enough.
Tight liquidity in the Chinese banking system, on top of liquidity problems arising from non-performing loans, comes from the fact that PBOC’s FX reserve accumulation has stopped due to capital outflow, such that PBOC balance sheet has remained more or less constant for about a year now. And as the economy is still growing (albeit at a much slower pace), the constant size of PBOC balance sheet means that the size of PBOC’s balance sheet is actually shrinking relative to the size of the economy, and that is exactly the opposite to what quantitative easing does to a central banks’ balance sheet. Thus we said yesterday that PBOC is inadvertently doing “quantitative tightening”. This has been a key theme we have been talking about for almost a year now.
The chart below extrapolates the old trend line of PBOC balance sheet expansion, overlaying with the actual size of balance sheet. If the PBOC’s balance sheet continued to expand at the previous rate (the average rate from Oct 2010 to Sept 2011), PBOC’s balance sheet would probably be RMB3 trillion larger than the actual size as of the end of July:
The PBOC can surely ease liquidity by cutting RRR and continuous reverse repo to offset the lack of balance sheet expansion (or shrinking of balance sheet relative to the economy). However, if the pre-existing pace of balance sheet expansion is needed to make PBOC’s life easier, it is easy to see that PBOC needs more than one or two RRR cuts or RMB1 trillion of net injection, just to keep liquidity conditions unchanged.