The 50bp cut to the reserve requirement ratio (RRR) for Chinese banks on Tuesday, together with record loan growth in January, could point to an increasing likelihood that the authorities are shifting policy to enable more credit-fueled growth, says Fitch Ratings. Next week’s National People’s Congress meeting should provide further information on the direction of Chinese economic policy and structural reform. Fitch maintains that a return to sustained rapid lending growth by Chinese banks would be credit negative, with leverage in the economy already high.
Fitch expects that credit growth (based on Fitch’s Adjusted Measure of Total Social Financing, FATSF) will continue slowing in 2016, to 13%. This is a necessary part of the broader structural adjustment in China’s economy to achieve more sustainable growth. However, credit growth will still be running above nominal GDP growth, meaning that total leverage (as measured by FATSF/GDP) will continue to rise, to 260% by end-2016.
A government target, announced in October, to double the size of China’s economy by 2020 also implies continued credit-fueled growth as current consumption trends would not be able to support targeted GDP without additional leverage.
The People’s Bank of China (PBOC) lowered the RRR to 17%, effective on 1 March, and Fitch expects the move implies an injection of CNY688bn (USD105bn) of liquidity into the financial system. This was the first broad-based RRR cut since October, when the central bank also reduced the ratio by 50bp. The current level for the RRR is still high in both historical terms and in relation to other countries, so there could be room for further reductions this year.
This latest RRR cut is likely to be a reflection in part of the continued economic deceleration in China and ongoing concerns about growth risks. PMI data for February, released yesterday, showed a drop in manufacturing activity, with the index falling to 49 from 49.8 in January. This marked the lowest manufacturing PMI figure since February 2009. Notably, too, the services sector PMI fell to its lowest level since the 2008 global financial crisis, which could be signaling a broader-based slowdown.
In the near term, RRR cuts could boost bank earnings by allowing banks to reinvest the liquidity freed up from the PBOC. It will also enable banks to roll over more debt and continue the trend to shift loans back on balance sheet. However, Fitch expects that the overall earnings impact from the 50bp cut, or even the series of cuts enacted since the beginning of 2015, is not likely to be significant. Furthermore, rolling over more debt will only delay and not resolve an expected rise in NPLs. Fitch expects reported NPL and ‘special mention’ loan ratios to rise in 2016 to 2.5% and 4.3%, respectively, from 1.7% and 3.8% at end-2015.