Monday, 23 July 2018

PBOC Watch: Easy come, easy go

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Shah: China’s slump in equities could put another RRR cut back into play.

China’s benchmark stock market index (SSEC) has been on an extraordinary ride: before the latest correction it had racked up gains topping 150% over a 52-week period. The sharp 7.4% loss on Friday puts the SSEC into bear-market territory, with two-week total losses since the high just exceeding 20%.

But despite the ‘correction’, the index is still up over 100% from its lows and suggests there is ample room for further downside. While the volatility is a concern, the correction is likely to be seen as healthy and much needed.

The weakness in equity markets also comes as mild capital inflows have returned, taking a further Reserve Requirement Ratio (RRR) cut off the radar for now. But the sharp drop may start to spur renewed outflows and bring another RRR cut back into view after the big 100-bp cut in April.

Remember RRR hikes/cuts have always been a measure to dampen the impact of capital flows more than an avenue to ease monetary policy. Take a look at a chart of China bank RRR against 3mth change in FX reserves. The injection of funds by the PBOC this week in the money markets should not be seen as having much bearing on the outlook for the RRR.

The use of reverse repos this week has thus far been relatively small (at Rmb35bn) but it sends a dual signal:

1) that the PBoC will ensure there is ample liquidity ahead of quarter/half year-end to avoid repeating the mess of two years ago, and

2) that a further drift higher on money market rates is unwelcome and likely to yield a further liquidity response.

Policymakers are still looking for policy to gain traction to support this year’s growth target of 7%. The equity market weakness will impact the outlook for RRR cuts via its effect on capital flows but is unlikely to have broader policy implications.

The direction of travel is likely toward a further rate cuts in Q3. Stability will be maintained on the renminbi as China aims to be included in the IMF’s SDR as a symbol of its progress in opening up markets.

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