July 07, 2014 00:00 By Suwatchai Songwanich
At the end of May, China's State Council released a policy blueprint on financial reforms that will set the scene for monetary policy for the second half of the year. This has important implications for both the economy and commercial banks.
Of particular importance is what’s called “directional drop quasi”. This is a very interesting and innovative approach to monetary policy that aims to increase available bank credit for business and reduce financing costs.
The main policy instrument is lowering the reserves banks are required to hold with the central bank – which were previously set at 20% of all deposits. The objective is to use monetary policy to support the real economy while avoiding speculation and the expansion of asset bubbles.
The lowered requirements are only available to banks which fit the policy criteria, namely a certain level of agricultural, small- and micro-business loans in their portfolio.
The People’s Bank of China, the country’s central bank, started to implement the policy at the beginning of June. By the middle of the month it was extended to cover a wide range of mid-sized banks including China Merchants Bank, Industrial Bank and China Minsheng Bank, and subsequently to more banks meeting the criteria. This followed a cut in the reserve-requirement ratio for rural banks by up to 2 per cent in April.
The increase in available credit for targeted banks is just one of a series of measures that have been introduced by China’s policy-makers to boost the economy. Other measures have included quicker fiscal disbursements and speeding up the construction of railways and public housing projects.
A move in the right direction
Just last week, the main banking regulator, the China Banking Regulatory Commission, also changed the way it calculates banks’ loan-to-deposit ratio, which is expected to channel more credit into the real economy. While it is too soon to say what impact this will have on the banking sector, it is certainly a move in the right direction.
Although each measure on its own may not have a huge impact on the economy, in combination they provide what China’s Premier Li calls a “smart, targeted” approach which will boost growth. On a recent visit to London he was adamant that China would be able to achieve growth of 7.5 percent both this year and into the future, and he said there would be no need to resort to strong stimulus measures as in the past.
His comments are significant given that many outside commentators have been predicting a hard landing for China’s economy. Li strongly denied this would happen.
While the debate over a soft or hard landing is certainly not over yet, recent economic indicators appear to support Li’s point of view. Since May, factory output, retail sales and fixed-asset investment have all risen.
Meanwhile in June, two closely watched Purchasing Managers Indices – which measure business sentiment – were better than expected, and both were at a six-month high.
Given the sluggish economic
situation in many parts of the world, many people will breathe a sigh of relief if these smart, targeted measures help China’s economy maintain robust growth.
They may also help the market play a more substantial role in allocating resources. This would be very positive for the future.