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Will China’s Latest Attempt at Propping Up Its Economy Work?

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PBoC cuts the reserve requirement ratio

China’s central bank, the People’s Bank of China (or PBoC), announced on January 4, 2019, that it will cut the reserve requirement ratio (or RRR) of Chinese (FXI) banks by 50 basis points on January 15 and a further 50 basis points on January 25. This move is expected to add 800 billion yuan in liquidity to the Chinese economy. To stimulate demand in the slowing economy, China’s central bank cut the RRR four times in 2019. Prior to the central bank’s decision to cut the RRR, China’s premier Li Keqiang has urged the central bank to cut the reserve requirements. He had also called on China’s leading commercial banks to increase lending to the private sector and small businesses.

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Domestic pressure and trade war

While domestic pressures had already started weighing on the economy, the US (DIA) (VOO)-China trade spat exacerbated China’s state. Most of the recent data points out of China are pointing toward a deepening slowdown. China’s manufacturing activity in December contracted for the first time in 19 months, according to the Caixin/Markit manufacturing PMI (purchasing managers’ index). Every new data point out of China (FXI) seems to confirm the market’s concerns about the slowdown in China. The data for China’s industrial profits, released on December 27, showed the first contraction in profits for industrial companies since December 2015. The November trade data showed that exports and imports have been growing less than expected. China’s November car (CARZ) sales data, which was released on December 11, showed a 14% YoY fall in sales.

Other measures to shore up the economy

Apart from the announced rate cuts, market participants are expecting other stimulation measures from the bank in 2019 to shore up the economy. They are now expecting that the PBoC could even reduce the benchmark rates, which have been steady for the last five years. A reduction in benchmark rates, however, is fraught with risks. It could lead to the flight of capital from China to regions with higher rates of interest, weigh on the yuan, and also ignite debt crisis. Therefore, Chinese authorities will have to tread with caution to balance growth and risk.

In the next part, we’ll see what measures analysts foresee from Chinese authorities to arrest the slowdown.

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