PBoC eases despite continued depreciation fears

Renminbi strengthened against the US dollar today (March 1) following the People's Bank of China's (PBoC) decision on Monday to cut banks' reserve requirement ratios (RRR), intensifying monetary stimulus despite recent months' rapid credit expansion and large-scale capital outflows.

The RRR cut off 50 basis points to 17% for major banks, the PBoC's first since October, is likely to furnish China's banking system with an immediate liquidity injection of 650–700 billion yuan, several banks predict.

Despite fears that lower interest rates prompted by such a liquidity injection may add to depreciation pressures, the yuan strengthened from 6.552 to 6.5408 against the dollar on March 1.

The RRR cut was made "in order to maintain adequate [financial system] liquidity" and "guide steady moderate growth of money and credit" so as to "create [an] appropriate monetary and financial environment", the PBoC says in an online statement.

The injection will likely alleviate a recent liquidity drain caused by capital outflows that caused PBoC FX reserves to fall by an additional $99 billion in January, say Hong Kong-based ANZ economists Raymond Yeung and Louis Lam in a note.

Donna Kwok, a Hong-Kong based economist at UBS, adds the PBoC "appears to be sending a clearer signal of monetary policy accommodation" following a recent easing of exchange rate pressures compared with earlier in the year.

"Additional RRR cuts have been expected and needed for a while to offset sizeable renminbi-depreciation-fanned capital outflows since last October's RRR cut," Kwok says in a note.

"However, the PBoC has until now been reluctant to deliver, preferring to use shorter liquidity provisioning or interest rate tools such as standing lending facilities and medium-term lending facilities instead, for fear of further aggravating renmimbi depreciation pressures."

China is currently in the midst of an intricate balancing act, attempting to buoy slowing growth while trying to limit capital outflows and maintain financial stability in an economy with the world's highest private debt burden. In addition, Bejing is trying to wean the economy off its dependence on fixed investments while boosting consumption – an unprecedented proposition.

"Even before the G20 finance ministers and central bank governors' [meeting in Shanghai] last week, the Chinese government had been indicating that it would be adopting more expansion fiscal and monetary policies to support growth," says Kwok.

At the same time, however, PBoC governor Zhou Xiaochuan underscored as recently as Friday that the central bank is prepared to push back against renewed currency depreciation, a potential outcome of lower interest rates.

"The PBoC will remain cautious about lowering the benchmark lending and deposit rates, given the current renminbi depreciation pressure," say Yeung and Lam.