Possible RRR cut sends proactive signals, experts say

China's central bank may reduce the amount of cash held as reserves from some financial institutions in the short term, as it aims at further strengthening financial support for rural development and maintaining liquidity at an ample level, analysts predicted on Friday.

They made the comments after the option of a cut in the reserve requirement ratio, or RRR, was mentioned at a recent video conference held by the People's Bank of China, the central bank, and five other government departments.

Possible monetary policy measures mentioned at the conference also include relending and rediscounting, which are aimed at promoting bank lending, according to a statement issued after the meeting late on Thursday.

After the meeting, many analysts from banks and securities firms said that the probability of a targeted RRR cut is increasing in the short term.

"An RRR cut, if announced, is more likely to be a targeted one, with the amount of net liquidity injections to be below 500 billion yuan ($77.2 billion)," said Lu Ting, chief economist in China with Nomura Securities.

Lu said that financial support from the central bank was likely to be earmarked for rural areas and sectors hit by the resurgence of the COVID-19 pandemic.

The central bank reduced the RRR for almost all financial institutions by 50 basis points on July 15, except for some rural financial institutions that already adopted the RRR at 5 percent, the lowest level. That cut injected about 1 trillion yuan of funds into the banking system.

But a single RRR cut cannot supplement the enlarging liquidity gap, as local governments plan to accelerate bond issuances and a large amount of the PBOC's medium-term lending facility, or MLF, will expire over the rest of the year, said economists.

The priority of monetary policy is to stabilize the growth of the real economy, as China may see headwinds in the third quarter due to the impact of the Delta variant. Economists from ING Bank expected that China's manufacturing purchasing managers' index for August, which will be announced next week, will reflect the impact of the latest COVID-19 cases, especially on trade, tourism and leisure activities.

The rapid spread of the Delta variant globally could also hurt overseas demand for Chinese goods, they said.

"Recently, the monetary policy showed more proactive signals, while the liquidity gap is still large in the second half," said Ming Ming, a senior researcher with Citic Securities.

A targeted RRR cut is possible by the end of this year, and the central bank is expected to maintain a stable interest rate level as well as ample liquidity, Ming added.

The Ministry of Finance issued a policy report on Friday, which pointed to the promotion of proactive fiscal measures in the second half. It said that macroeconomic policies will be more targeted, while budgetary fiscal spending and local government bond issuance will accelerate, aiming to support the real economy and promote employment.

The ministry called for consolidating the stability and positive trend of the economy, while coping with possible cyclical risks.

Other than a targeted RRR cut, the central bank can inject long-term liquidity through relending and rediscounting facilities, as well as ease constraints to some extent on the financing of local government financing platforms, said Lu from Nomura.

"The likelihood of a rate cut, mainly the one-year MLF rate and seven-day repo rate, is on the rise, though the probability of a rate cut is still significantly below that of a targeted RRR cut, and the timing of any rate cut would most likely be after a targeted RRR cut," he added.