Liquidity shortage cited as reason for sudden drop

BEIJING / SHANGHAI - China's central bank lowered reserve requirements for commercial lenders for the first time since December 2008, a sign the country has started to ease its monetary stance as white-hot inflation is contained and economic uncertainties increase.

The central bank will reduce the ratio of money that banks have to set aside on deposit by 50 basis points among commercial lenders, effective on Dec 5, said the People's Bank of China in a statement on Wednesday.

After the move, the reserve ratio for major banks will be 21 percent, while the ratio for small and medium-sized lenders will stand at 17.5 percent. Analysts expect the cut in the ratio will inject 350 to 400 billion yuan ($55 to $63 billion) into the market.

"The cut falls within expectations. The current liquidity in the Chinese banking system has become too tight and the liquidity shortage forced the central bank to inject money into the market," said Ma Jun, chief economist at Deutsche Bank Greater China.

China has increased the reserve ratio 12 times since 2010 to soak up liquidity and curb inflation, including six times in the first half of this year.

The latest move came a little earlier than expected and was mainly due to the dramatic decrease of yuan positions for foreign exchange purchases among Chinese bankers, said Li Huiyong, a Shanghai-based economist with Shenyin & Wanguo Securities Co.

In October, the yuan positions - an indicator of "hot money" inflows or outflows - fell for the first time in four years as it went down by 24.9 billion yuan.

"The passive contraction of liquidity and non-optimistic economic prospects jointly generated the necessity to inject more money," Li said, adding the cut indicated that the yuan positions for November will probably continue to decline.

Analysts expected the tone of China's macro policy may change during the nation's annual Central Economic Work Conference, which is scheduled this month, as inflation has already started easing.

Lu Zhiming, economist at the Bank of Communications Ltd, said the country's inflation rate is predicted to fall for a fourth consecutive month in November as the consumer price index, a main gauge of inflation, is likely to drop to 4.3 percent, dragged down by lower food prices, declines in global commodity prices and a higher base figure of one year earlier.

The index for 2011 will be 5.4 percent, before it falls to somewhere between 3 and 3.5 percent next year, he predicted.

Liu Ligang, head of Greater China economics at ANZ Banking Group, predicted an official purchasing managers' index for November will be around 49.7, the first time that the index would have fallen below the contraction line of 50 since February 2009.

"We believe it's very necessary for authorities to loosen the monetary stance generally to stimulate the economy."

He said a slide in property transaction volumes of more than 30 percent and slumping real estate prices add to the likelihood the Chinese economy may experience a hard landing.

But Guo Tianyong, economist at the Central University of Finance and Economics, said the cut in the reserve ratio should not be seen as a change in macro policy tone, because it mainly targeted the net liquidity drain among banks due to capital outflows in October.

"The monetary stance needs to remain relatively tight given that inflation is still at high levels, and given that economic restructuring as well as curbs on the real estate market are still ongoing," Guo said.

"We indeed predicted that China will loosen its monetary policies, but the government will not make the change high profile," said Wang Tao, head of China economic research at UBS Securities Co Ltd, adding the traditional year-end increase in expenditures of the nation's fiscal deposit will inject more liquidity into the system.

Lu said interest rates will stay the same for a while. "The right time for an interest rate cut has not arrived," Lu said.

Tian Yuan, a macroeconomics analyst at Bank of America Merrill Lynch, said the move doesn't necessarily mean that the People's Bank of China will change the direction of its monetary policy.

"The move is within our expectations, but it's mainly targeted at the banking system, which has witnessed a decline in deposits in recent months," she said.

"If the banks don't have enough money to lend, that will be a big problem in China, where bank loans are the main source of funding."

But she added that liquidity is still ample in society as a whole, and loosening monetary policies too much threatens to fuel inflation, which has just slightly eased.

Tian added that lowering the reserve ratio won't have an impact on the country's property market, which has just shown signs of decline after various government measures.

"The banks are simply not allowed to lend to developers. It's not about how much money they have," she said.

Wang Jianhui, chief economist with Southwest Securities Co Ltd, said the move marks the end of this round of tightening.

"Exports will probably face a sharp decline next year and the country's enterprises are seeing increasing raw material prices and wages. So if the tightening continues there will be problems in economic growth," he said.

The faster-than-expected reduction in the reserve ratio should be read in the context of the latest data from the purchasing managers' index, said Fan Cheuk Wan, managing director of Credit Suisse.

"If the index only declines modestly, a reduction in the reserve ratio may signal that economic growth is just slowing down. However, if the index drops drastically, it could flag the possibility of a hard landing," Fan said.

The reduction could be a pre-emptive action to buffer the impact of a possibly poor purchasing managers' index, suggested Banny Lam, associate director and economist at CCB International Securities.

George Ng and Oswald Chen in Hong Kong contributed to this story.