China injects $109bn into economy

China’s central bank will cut the reserve requirement ratio by 1% to inject $109 bn (750bn yuan) against the negative impacts of the trade war with the US.

China’s central bank said on Monday that it lent 265 billion yuan ($38.58 billion) to financial institutions via its one-year medium-term lending facility (MLF) with rates unchanged.

Background

US imposed tariffs on nearly half of all Chinese imports into the US. China has retaliated with its own set of tariffs thus beginning a trade war between world’s two biggest economies. President Donald Trump kicked off the trade war in June by slapping additional tariffs piling up pressure on China to reduce over $335 billion trade deficit in the $ 710.4 billion bilateral trade.

Behind the trade, dispute aisU.S. allegations that China uses predatory tactics with a determination to overtake American technological dominance. These tactics, the U.S. charges, include cyber theft of U.S. companies' trade secrets and a requirement that foreign companies’ hand over proprietary technology as the price of access to the Chinese market.

China is unable to match US tariffs because it exports far more to the US than it imports from the rival country. The trade surplus suggests that China has far more to lose economically, but that doesn’t mean Beijing does not have the capacity to retaliate.

Analysis

China is pouring more cash into its slumping economy as it braces for further problems caused by the trade war with the United States. The government of China had made efforts to curb high levels of debts while the US imposed tariffs more than $250 billion on Chinese exports.

China’s central bank, People’s Bank of China, will cut the reserve requirement ratios (RRRs) by one percentage point from 15 October to lower financing costs and spur growth in the world’s second-biggest economy.

Reserve requirement ratios (RRRs) - currently 15.5% for large commercial lenders and 13.5% for smaller banks - would be cut by 100 basis points from October 15, the PBOC said.  The cut will release a total of 1.2 trillion yuan ($175 billion), of which 450 billion yuan is to be used to repay existing medium-term funding facilities which are maturing, the central bank said. It is the fourth time this year, it has cut the amount of money banks are required to keep in reserve. This decision came after Beijing pledged to speed up plans to invest billions of dollars in infrastructure projects as the economy shows signs of cooling further. 

Investment growth has slowed to a record low and net exports have been a drag on growth in the first half of the year. Chinese officials have already turned to tax cuts, infrastructure spending and looser monetary policy as they seek to spur more economic activity. China's stock market has also pummelled by fears about the economy and intensifying trade war. This PBOC’s move can jolt the global share market to live. China’s banking regulator has asked banks to significantly lower funding costs for smaller firms and raise their tolerance for non-performing ratios for loans to small and micro firms.

The injection of 750bn yuan into the economy will supposedly help in easing the impact of higher US tariffs on Chinese exports. The central bank said the reserve cut would not see the yuan devalued and that monetary policy would remain “prudent and neutral”. The cut will apply to large commercial banks, joint-stock commercial banks, city commercial banks, non-county rural commercial banks and foreign banks, according to the statement.

The move was not expected by market participants because no MLF loans were due to mature on Monday.

In the past, the People’s Bank of China (PBOC) typically injected liquidity through MLF loans on the day existing loans were due to mature, but since June it has injected funds even when no debt was maturing.

Counterpoint

The People's Bank of China is moving in the opposite direction from the US Federal Reserve, which last month raised interest rates for the third time this year. That makes it increasingly appealing for investors to hold assets in dollars rather than the yuan.

Assessment

Our assessment is that as the trade war prolongs, China has to take measures to avoid massive outflow from its financial system. A neutral money policy will not stimulate or slow the economy down. Lowering the reserve ratio leads to the devaluation of the domestic currency because banks use the extra money available to lend more and this reduces interest rates. The central bank has shifted to looser monetary policies as combined effects of Beijing’s financial cleanup and the trade conflict with the US has threatened the economic expansion.