The People’s Bank of China (PBoC) reduced RRR by 100bps in April followed by a 50bps cut in July. Prior to this rate reduction, we were expecting two 50bps cuts before the end of 2018. We now think that an additional 50bps cut in December is still likely after the latest reduction, depending on the performance of real activity data in the next one to two months. For 2019, we are tentatively factoring in continued RRR-easing – adding up to 100-150bps – in our forecast, assuming a lingering trade war.
RRR hikes era over
As we have argued before, the era of RRR hikes starting from 2006 was triggered by the persistent influx of foreign liquidity that had resulted in the PBoC’s prolonged efforts to mop up excess cash. This ended in 2015 and China has since embarked on RRR cuts to release massive locked liquidity back to the banking systems. This represents a structural trend of monetary easing which the PBoC will continue at a time of economic downswing.
According to the central bank’s policy statement the 100bps RRR cut will release about RMB1.3trn (USD174bn) fresh liquidity into the banking system, accounting for about 13% of total bank deposits.
RMB450bn will be earmarked to pay maturing medium-term lending facility (MLF) loans as these loans have resumed noticeably over the recent two quarters, but with a shorter maturity of about three months to one year. The MLF payment would have drained liquidity if the PBoC did not provide fresh liquidity injection through the RRR reduction.
Excluding MLF payments, the PBoC said that the remaining RMB750bn injection will have direct impact on the economy. In our view, this will have a similar net effect as a 50bps RRR cut.
Impact of US mid-term elections
If the trade war does not escalate during the US mid-term elections in 4Q18, the actual near-time downside drag on China’s growth is not significant.
The US trade tariffs as of today (25% tariff on the first USD50bn of exports followed by 10% on USD200bn) is expected to directly affect China’s GDP growth by 40bps over a year, other things being equal.
An increase in tariffs to 25% on USD200bn of exports will have a total effect of about 80bps of China’s GDP. If all Chinese exports (USD500bn worth) are eventually taxed, it may drag down China’s GDP growth by a more severe 150bps.
Minimal downside growth risk
Based on developments so far, the downside growth risk to China is insubstantial. Beijing can afford to maintain its measured and gradual policy response and growth recovery should be more visible down the road as the earlier impact of de-leveraging starts to fade. This should include fiscal measures as Beijing can trim certain tax rates or tax buckets to support targeted industries (infrastructure, technology, and some SMEs) and the household sector, without embarking on a sizeable fiscal stimulus package.
Longer-term still uncertain
It is important to watch if the Sino-US trade dispute will extend into geopolitical issues or cyber-attacks, as hinted by US vice-president Mike Pence at his Hudson Institute speech in the previous week.
In the worst-case scenario, a branching out of Trump’s anti-China strategy to non-trade measures would mean hostility rising to the next level, which may then result in a protracted risk premium placed on the Chinese market. However, if this means that Trump, while amplifying his rhetoric on China, is actually turning more cautious on his next tariff moves and monitoring its impact on US inflation and consumers, that may not be too bad an outcome. Stay tuned.
Chief Asia Investment Strategist