He Jiang

Reduction in Reserve Requirement Ratio in China

China has experienced a outstanding economic growth after the "reform and open-

up policy". However, according to the data from the World Bank, China's GDP

growth rate began to slow down after the year 2007. In the first quarter of 2015, the

GDP growth was 7% which is the lowest growth rate in the last 6 years. In order to

boost China's economy, China's central bank(PBOC) made several cuts in

RRR(Reserve Requirement Ratio) since 2012. The cuts in RRR allow commercial

banks to lend more money to businesses and increase the money liquidity in the

market. On Sunday April 20th, PBOC announced to cut the RRR by 1% which is the

biggest cut since December 2008. This paper analyzes how will the RRR cuts affect

China's economy from the financial, stock market, real estate market as well as

currency exchange rate perspectives.

History and Importance of RRR

Reserve Requirement refers to the minimum fraction of consumer deposits and

notes that each commercial bank must hold as reserve. Tito Cordella points out that

RRR has been used fairly frequency as a macroeconomic stabilization tool especially

for developing countries. And it also a useful tool to smooth out the business cycle1.

1

Cordella, Tito, and Ebooks Corporation. Reserve Requirements in the Brave New

Macroprudential World. Washington, D.C: The World Bank, 2014

China began to use RRR policy to adjust the economy since the year 1984. In China,

RRR and Interest rate are the two powerful tools used by the central bank (PBOC) to

maintain the value of currency and to stabilize the economic growth.

RRR and CPI

In China, one of the most important roles of RRR is to be the inflation fighting

tool. The increase in RRR could reduce the money supply in the market, and the

reduction in money supply will contribute to the control of CPI. Therefore, two of the

biggest questions concerned by Chinese economists are whether the cuts in RRR will

increase the CPI and whether it will result in the speculation in real estate market.

One of China's economists Yu argues that China's current economy exposed

several potential problem including overheated economy and the increasing of

inflationary pressure2. However, according to the data from the World Bank (Chart 1),

the annual GDP growth in China began to decline since the year 2007. Therefore, the

economy has already been slowed down, the overheated economic period has already

passed. Meanwhile, China's RRR began to cut since the year 2012. By contrast, U.S.

has been used a very loose monetary policy since 2009. The interest rate in U.S. is

even close to zero. By comparing the annual GDP growth in China and U.S., we could

see that there has been a very well recovery in U.S.'s economy since 2009. By

contrast, China's has experienced a downtrend economic growth rate since 2007 under

its tightening monetary policies. Under the current situation, there is no need for

2 Dong Yu, Research on the effect of deposit reserve rate change on stock price and listed

commercial banks in China, Liaoning: Ocean University of China, 2012

China to control the overheated economy. On the contrary, there has been a urgent

need to reduce RRR in order to stimulate the economy.

On the other hand, from the inflationary perspective, Chart2 is China's annual CPI

from 2008-2014. From this chart, the highest CPI occurred in the year 2011 which is

5.4%. However, the CPI began to decline since 2012. And the annual CPI for 2012,

2013 and 2014 are 2.7%, 2.6% and 2% which are all below the 3.5% CPI upper limit

suggested by the central bank. Therefore, there is no need to control the inflation in

China since there has been no such a problem since 2012. By contrast, the PPI

decreased by 1.9% in the year 2014 which show a signal of deflation.

RRR and Real Estate Market

Another doubt is whether the RRR cuts will result in the speculation in real estate

market. Real estate market is very money sensitive. From the historical perspective,

the changes in RRR have great effect in real estate market. But due to the home-

purchase restriction policy, the growth rate of China's housing price has a downtrend

since 2008. In the year 2011-2013, the housing price even declined. Therefore, even

though the strong RRR reduction could possibly lead to an increase in housing price,

it's less likely to cause the sharp increase since the effective police of home-purchase

restriction.

In the mean while, China's current economy is urgent for recovery. It is also not

reasonable to slow down whole economic growth just to control the housing price in

big cities.

RRR and Financial Market

Monetary policy change can bring great influence to financial markets3. RRR is

one of the most powerful monetary tool in China. And it is seldom used by other

countries. China chose to use tightening monetary policies and controlled the credit

loans after the financial crisis. Under this situation, it's difficult for businesses to

borrow loans from commercial banks. Therefore, a lot of businesses especially small

and medium size businesses faced severe financial problem. The 1% RRR reduction

in April 2015 mean the Chinese central bank will release 1.2 trillion Yuan to the

market. After the adjustment, the current RRRs for large financial institutions and

small and medium size institutions are respectively 19.5% and 16%. This policy will

allow commercial banks to give more credit loans to businesses. Therefore, the

financial problem could be relieved to some degree.

RRR and Stock Market

3 P. Sellin, Monetary policy and the stock market: theory and empirical evidence, Journal of Economic

Surveys 15, 2001

From the stock market perspective, Jin believes that RRR is an lagging and

unstable indicator to the stock market4. Following column is the historical data of

RRR adjustments and the one-month changes in Shanghai composite index after the

adjustments. And Chart 3 is the overall trend of Shanghai Composite Index from

2003-2015. As we can see from the column 1 and chart 4, PBOC gradually raised the

RRR from Jan. 2010 till Nov. 2011. In this period of time, even through the short-term

stock market did not fluctuate with the RRR adjustments, the overall stock market

declined from late 2010 to the mid 2012. Hence, the historical data once again prove

that in the RRR is an unstable indicator to the short term stock market. In the long

run, the overall trend of the stock market fluctuates with the RRR adjustment but

several months behind the adjustments.

In the mean while, the RRR policy could also affect people's expectations toward

the future market. That is to say the reduction in RRR would give people more

confidence towards the future economy. Therefore, it is reasonable to expect a bull

market in China several month after April 2015.

Date

Large Financial InstitutionsSmall & Medium Size Financial

Institution

Stock Market

(One Month)

Before

Adjustment

After

Adjustment%

Before

Adjustment

After

Adjustment%

Shanghai

Composite

Index

02/18/2012 21% 20.5%-

0.50%17.50% 17.00% -0.50% 0.30%

4 Jin, Liling. 存款准备金率的调整对我国股票市场的影响[D]. Sichuan：Southwestern University of

Finance and Economics，2012.

11/30/2011 21.50% 21%-

0.50%18% 17.50% -0.50% 2.29%

06/04/2011 21% 21.50% 0.50% 17.50% 18% 0.50% -0.95%

05/12/2011 20.50% 21% 0.50% 17.00% 17.50% 0.50% 0.95%

04/07/2011 20% 20.50% 0.50% 16.50% 17.00% 0.50% 0.22%

03/18/2011 19.50% 20.00% 0.50% 16.00% 16.50% 0.50% 0.08%

02/18/2011 19.00% 19.50% 0.50% 15.50% 16.00% 0.50% 1.12%

01/14/2011 18.50% 19.00% 0.50% 15.00% 15.50% 0.50% -3.03%

12/10/2010 18.00% 18.50% 0.50% 14.50% 15.00% 0.50% 2.88%

11/10/2010 17.50% 18.00% 0.50% 14.00% 14.50% 0.50% -0.15%

11/10/2010 17.00% 17.50% 0.50% 13.50% 14.00% 0.50% 1.04%

05/02/2010 16.50% 17.00% 0.50% 13.50% 13.50% 0.00% -1.23%

02/12/2010 16.00% 16.50% 0.50% 13.50% 13.50% 0.00% -0.49%

01/12/2010 15.50% 16.00% 0.50% 13.50% 13.50% 0.00% -3.09%

12/22/2008 16.00% 15.50%-

0.50%14.00% 13.50% -0.50% -4.55%

11/26/2008 17.00% 16.00%-

1.00%16.00% 14.00% -2.00% -2.44%

10/08/2008 17.50% 17.00%-

0.50%16.50% 16.00% -0.50% -0.84%

09/15/2008 17.50% 17.50% 0.00% 17.50% 16.50% -1.00% -4.47%

06/07/2008 16.50% 17.50% 1.00% 16.50% 17.50% 1.00% -7.73%

05/12/2008 16.00% 16.50% 0.50% 16.00% 16.50% 0.50% -1.84%

04/16/2008 15.50% 16.00% 0.50% 15.50% 16.00% 0.50% -2.09%

03/18/2008 15.00% 15.50% 0.50% 15.00% 15.50% 0.50% 2.53%

01/16/2008 14.50% 15.00% 0.50% 14.50% 15.00% 0.50% -2.63%

08/12/2007 13.50% 14.50% 1.00% 13.50% 14.50% 1.00% 1.38%

10/11/2007 13.00% 13.50% 0.50% 13.00% 13.50% 0.50% -2.40%

10/13/2007 12.50% 13.00% 0.50% 12.50% 13.00% 0.50% 2.15%

09/06/2007 12.00% 12.50% 0.50% 12.00% 12.50% 0.50% -2.16%

RRR and Currency Exchange Rate

Theoretically, the increase in money supply will cause the currency depreciation.

But the depreciation of RMB has to face both domestic and international pressures.

On the one hand, China has to face the large external imbalance caused by the huge

export suplus. On the other hand, the export surplus means the deficits to China's

trading partners. Since 2006, there were more than 100 cases of the anti-dumping and

anti-subsidy import restrictions on China imposed by U.S. and EU5. Indeed, U.S also

use the political power to force the appreciation of RMB. Therefore, despite there is

an increase in money supply, it's less likely to have a sharp depreciation in RMB due

to the political pressures and the trade restrictions.

Conclusion and Policy Suggestion

5 John Knight and Wei Wang, China's Macroeconomic Imbalance: Cause and Consequences, University

of Oxford, 2011

RRR is one of the most powerful tools used by PBOC to adjust China's economy

from a macro level. The reduction in RRR could increase the money liquidity in the

market, help businesses relief their financial difficulties, stimulate China's current

stagnant economy and cause the raise in stock market. There might be a possible

speculation in real estate market, and the RRR cuts would give pressure to the

appreciation of RMB. But the side effects cannot even compete with the benefits it

brings. Indeed, China's current CPI is not high, there is still much space for the

possible inflation in the future. The decline in CPI indicates a good timing for the

reduction. In order to quickly step off the stagnated economic condition, the reduction

in RRR is necessary and inevitable to China. To cut the RRR in China is to do the

right thing in the right time.

In the mean while, there is still a 19.5% of RRR for the large financial institutions

and a 16% for the small and medium size financial institutions which show that there

is still enough space for the future reduction. Indeed, the RRR cuts could work with

the interest rate reduction when it is necessary.

References:

(1) Chart 1 : Data from The World Bank(2) Chart 2: Data from the World Bank(3) Chart 3: Data from eHome day(4) Column 1: Data from PBOC(5) Chart 4: Data from Investing.com(6) Cordella, Tito, and Ebooks Corporation. Reserve Requirements in the Brave New Macroprudential World. Washington, D.C: The World Bank, 2014(7) Yu, Dong, Research on the effect of deposit reserve rate change on stock price and listed commercial banks in China, Liaoning: Ocean University of China, 2012(8) P. Sellin, Monetary policy and the stock market: theory and empirical evidence, Journal of Economic Surveys 15, 2001(9) Jin, Liling. 存款准备金率的调整对我国股票市场的影响[D]. Sichuan：Southwestern University of Finance and Economics，2012.(10) John Knight and Wei Wang, China's Macroeconomic Imbalance: Cause and Consequences, University of Oxford, 2011