Slowdown, default risks to prompt China reserve cut-sources

BEIJING (Reuters) - Having reduced the amount of reserves that lenders must hold just two months ago, China’s central bank could soon do it again to support a slowing economy and contain risks posed by corporate debt defaults, policy sources said.

A China yuan note is seen in this illustration photo May 31, 2017. REUTERS/Thomas White/Illustration

A three-year deleveraging drive is making progress, but has also driven up borrowing costs and tightened credit, seen as a factor in some private defaults and hampering local government investment.

Weaker-than-expected activity data on Thursday, following other figures showing a sharp contraction in shadow banking activity, could help tilt the People’s Bank of China (PBOC) towards a slight easing, policy insiders said.

The PBOC’s decision not to follow this week’s U.S. Federal Reserve rate rise with even a symbolic rise - a break from its recent practice - signaled that some policy fine-tuning is in the offing, they said.

“Monetary policy could be slightly loosened under the ‘prudent and neutral’ stance, and such loosening should be targeted rather than across-the-board,” said a policy source who advises the government.

“There is room for cutting RRR (reserve requirement ratio) in the next 1-2 months as China’s economy faces downward pressure and also uncertainties from a trade war with the United States.”

In April, a month after nudging up short-term rates by 5 basis points, the PBOC unexpectedly cut the RRR by 100 basis points. That released about 1.3 trillion yuan ($202.7 billion), with 900 billion yuan used by big banks to repay medium-term lending facility (MLF) loans and 400 billion yuan for small banks to lend to small firms.

“Monetary policy is moving towards the direction of loosening. If you don’t offset the impact from deleveraging, it’s actually tightening,” said a second policy source.

The sources are involved in internal policy discussions but are not part of the final decision-making process. They spoke on condition on anonymity.

The PBOC has yet to respond to Reuters’ request for comment.


Data shows China’s deleveraging campaign is having some success.

Overall debt rose 2.7 percentage points in 2017 to 250.3 percent of gross domestic product, slowing from average growth of 13.5 percentage points between 2012 and 2016, PBOC data showed.

The corporate debt ratio fell 0.7 percentage point last year to 159 percent of GDP - the first decline since 2011, while the household debt ratio climbed 4 percentage points to 55.1 percent, the data showed.

The PBOC’s next RRR cut could be similar in scale to April’s 100 basis-point reduction, and more cuts are expected in coming years as it allows banks to replace maturing MLF loans with cheaper, longer-term funding and spur lending to small firms, the policy insiders said.

Total social financing (TSF), a broad measure of credit and liquidity in the economy that includes off-balance sheet forms of financing that exist outside the conventional banking system, dropped by more than 50 percent from April to 760.8 billion yuan in May.

And the weighted average lending rate for non-financial firms, a key indicator reflecting corporate funding costs, rose 22 basis points in the first quarter to 5.96 percent, following a rise of 47 basis points in 2017, central bank data showed.

Money market rates and bond yields have rebounded after a brief decline following the RRR cut in April.

As the central bank lent 463 billion yuan via its 1-year MLF on June 6, there is less of a case for an immediate followup reduction in RRR. The move increased outstanding MLF loans by a net 203.5 billion yuan to 4.2205 trillion yuan.


While authorities are seen pushing ahead with deleveraging, there have been some nuanced shifts in language from policymakers that suggest concerns over economic activity arising from trade tensions with the United States that could hit exports and from the crackdown on debt and risk.

In its first-quarter policy report, released in May, the PBOC pledged to “grasp the balance between stabilizing growth, structural adjustment and risk prevention”, dropping a reference to deleveraging contained in the previous report.

In April, a meeting of Politburo, a top decision-making body of the ruling Communist Party, added “expanding domestic demand” back to the policy statement issued by state media, after dropping it in December.

As of early June, 12 companies had defaulted on principal or interest payments on 19 bonds worth a total of 17.4 billion yuan this year, according to data compiled by Reuters.

And several companies controlled by local governments have failed to repay off-balance sheet loans.

“Deleveraging could continue but we should have an overall balance with monetary policy,” said one of the sources.

“Market interest rates are high and liquidity is tight. Some firms have defaulted on debt as they cannot roll over loans. We need appropriate policy fine-tuning to ease the situation.”

($1 = 6.4135 Chinese yuan renminbi)

Editing by Simon Cameron-Moore