HEARD : MORE CHINA EASING IS NO MAGIC WAND / THE WALL STREET JOURNAL

Heard on the Street

Heard: More China Easing Is No Magic Wand

By Aaron Back

Dec. 5, 2014 2:41 a.m. ET

Judging by China’s epic stock rally, investors are brimming with excitement over Beijing’s next loosening move. It might be a little too much excitement.
 
One possibility is that the People’s Bank of China will cut the ratio of deposits that banks must hold in reserve. When the central bank cut interest rates in November, it expressed concern about the cost and availability of credit in the system, especially to small and medium companies.

But cutting interest rates alone mainly reduces borrowing costs for huge, state-owned enterprises. Lowering the reserve ratio would complement the rate cut by increasing the pool of money available to loan out.

It is puzzling that the central bank hasn’t lowered the ratio already. Historically it has used the tool more frequently than it has adjusted interest rates, and often in response to changes in flows of foreign funds.

Inflows of foreign money, long a source of fresh cash for the banking system, have dried up as a result of slowing growth and reduced expectations for yuan appreciation. That has restricted liquidity in the financial system. Foreign exchange purchases by financial institutions, a proxy for fund inflows, came to 894 billion yuan ($145 billion) in the first 10 months of this year, compared with 2.11 trillion yuan in the same period last year.

Cutting the reserve ratio, currently at 20% for large banks, by the usual increment of half a percentage point would boost banking system liquidity by around 500 billion yuan ($81 billion), Bank of America Merrill Lynch economist Lu Ting estimates. To put such a move in perspective, already this year the central bank has quietly injected around three times that much into the system through various forms of covert, experimental lending facilities, only disclosing the actions weeks afterward.

Those unorthodox moves represent temporary money, often three-month loans. A reserve ratio cut is more permanent, so might pack a bit more punch. That said, looking ahead, any campaign of cuts is unlikely to drive reserve ratio requirements anywhere close to the levels of the 2009 lending boom, when it was at 15.5%.

Expectations for a reserve ratio cut have driven the rally in China bank stocks. While it is hard to predict when a mania-fueled rally will peter out, the current optimism looks overdone. A CSI index of Chinese banks, for instance, is up 25% over the past six trading days. That China’s beleaguered banks can lend an additional half-percentage point of deposits will certainly help their position. But it won’t work magic.