Channeling Liquidity Into Real Economy
The People's Bank of China, the central bank, cut the reserve requirement ratio by 0.5 percentage points, on May 18. The reserve requirement is the amount commercial banks must keep with the central bank. The reduction is estimated to inject 420 billion yuan ($66.44 billion) into the market.
To get the best results from the ratio cut, policymakers have to make sure the released liquidity flows to the real economy.
There are several reasons for the ratio cut. First, inflationary pressure has subsided as the consumer price index (CPI) rose 3.4 percent year on year in April, lower than the 3.5-percent one-year benchmark deposit rate. Second, the growth of the yuan counterparts of China's foreign exchange reserves has slowed down. Third, the stock market remains sluggish. Finally, the central bank's move indicates that economic slowdown continued in April.
But lowering the reserve requirement ratio may not be very helpful for salvaging the real economy but deviate from the direction of China's real estate macro-control.
The key for economic development lies in promoting the real economy by saving those cash-strapped enterprises. So it's important to ensure that liquidity flows to the real economic entities. Otherwise, it will flock to other areas, such as the property or stock markets, where there are more speculative activities.
However, judging from the current condition of the real economy, the 420 billion yuan ($66.44 billion) released from the ratio cut can hardly reach the real economy.
In fact, the market doesn't lack liquidity in a general sense. What's badly needed is a mechanism to guide the liquidity into the real economy. Without the mechanism, injecting more liquidity to the market is questionable.
Countless examples in the past several years show that excess liquidity may deal a heavy blow to prices. With a lower reserve requirement ratio, part of the liquidity may cause speculative activities in agricultural product sector, pushing up the inflation level in the country.
Admittedly, lowering the reserve requirement ratio can be helpful to enterprises. But Chinese enterprises are facing difficulties in daily operations, with their output and profits nose-diving. It's quite difficult for them to absorb the liquidity released from the ratio cut. In light of this, lowering the interest rate is more feasible and efficient than lowering the reserve requirement ratio.
A lowered reserve requirement ratio can be conducive to the stock market in the short run. But if the macroeconomic fundamentals continue to deteriorate, even the ratio cut won't reverse the worsening condition of the stock market.
For the property market, lowering the ratio is really good news. Right now, what bothers real estate developers most is the liquidity crunch or even the risk of capital chain breaks. Some cash-strapped property developers are now forced to launch big sales campaigns. But if their capital problem is solved, housing prices may continue to be kept at high levels. If so, the ratio cut is apparently harmful to property market regulation.
China is facing mixed stress stemming from inflation and the slowdown of economic growth, leaving less and less room for the monetary policies. Frequent use of quantitative measures, rather than combining them with price instruments, will have limited effect.
This is an edited excerpt of an article published in The Beijing News
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