Inside China’s Monetary String-Pulling

Here’s how policymakers are trying to engineer a soft landing

   
Inside China’s Monetary String-Pulling

These days, it’s not just Ben Bernanke and his merry band of central bankers who are tinkering around with monetary policy. On the opposite side of the globe, Chinese policymakers also are conducting their own form of monetary puppetry, only instead of terms like QE3 or Operation Twist, the Chinese pull the strings on what’s known as the “RRR.”

In its latest move, on Saturday, the People’s Bank of China said it will cut the reserve requirement ratio, or RRR, by a half a percentage point effective this Friday, May 18. The move is estimated to free about $70 billion for lending to stimulate the economy.

But just what is the RRR? Well, it’s the ratio, or the level of deposits, that banks must hold in reserve rather than lend out. After the Friday reserve ratio cut, banks will have to keep only 20% of their lendable cash on reserve.

The theory here is that by cutting the RRR, banks will have more money to lend out, and that will create more demand for loans, thus revving the engine of Chinese economic growth.

Although not directly parallel, think of the move as China’s version of the Fed buying bonds or increasing liquidity through more quantitative easing. And though the methods are slightly different, the goal is similar: to inject more capital into the system — but without causing a massive influx of inflation-generating money into the system the way an outright cut in interest rates would.

For China, the RRR reduction is nothing new. In fact, the latest cut is the third so far in the current cycle of monetary-policy loosening. The two previous cuts took place in February and November.

Most China observers, including myself, suspect that the People’s Bank move is really symbolic and more of a show of willingness by Beijing policymakers to loosen the monetary reins than anything else. Moreover, the reduction in RRR isn’t likely to have a major impact on Chinese economic growth because businesses aren’t exactly lining up and waiting to get cash right now.

The more important thing here is that Beijing keeps taking the steps needed to engineer a “soft landing” — and based on the official China growth metrics of 8.1% year-over-year GDP growth in the first quarter, that’s precisely what policymakers have been able to do so far. For the Chinese economy to be considered as hitting the skids and diving into “hard landing” territory, it would have to experience consistent quarterly growth of 7% or less for multiple quarters, and it’s nowhere near that metric.

Still, the move to ease the RRR is a welcome step after the latest data, released last Thursday, which showed growth in imports were basically flat for April compared with the prior year. China’s exports also grew half as fast as expected in April, according to figures released last week by the National Bureau of Statistics in Beijing.

One interesting thing to note is that China’s reserve requirements are roughly twice that of those in the West (although structurally, it’s hard to make apples-to-apple comparisons between the two banking systems). Still, the 20% RRR is high enough to permit many more cuts if Beijing policymakers deem such moves necessary.

I suspect that as long as inflation remains tame (consumer prices rose just 3.4% in April from the prior year), we’re liable to see more loosening of the reserve requirements, and more attempts to engineer the soft landing that the entire global economy needs to keep moving forward.

For investors who favor Chinese stocks, the RRR cut may also be a ray of light in an otherwise dreary 2012. Year-to-date, the iShares FTSE China 25 Index (NYSE:FXI), the biggest ETF pegged to China’s fortunes, is down 3.5%. That decline has really ramped up, however, during the last three months, with the fund sinking nearly 14% since mid-February.

The bottom line here is that the RRR cut basically confirms what we already know about China’s economy. Namely, that its rate of growth is slowing and that Beijing is committed to engineering a cushioned landing. Moreover, intrepid investors willing to bet on Beijing’s monetary engineering prowess may also be staring at a nice buying opportunity in FXI, especially after the fund’s recent pullback.

At of this writing, Jim Woods held no positions in any stocks mentioned in this article.


Article printed from InvestorPlace Media, http://investorplace.com/2012/05/inside-chinas-monetary-string-pulling/.

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