Yesterday, the People’s Bank of China performed a reverse repo auction, injecting some RMB143 billion of liquidity into the banking system, largest of such operation in 6 months to ease liquidity.
Liquidity usually tightens towards half-year end as they prepare for the half-yearly snapshot of their balance sheet, so banks all attempted to increase deposits (which appeared to be successful by the way, although the number looked surreal). Along with other reasons being suggested from various sources, the tight liquidity condition persists beyond the half-yearly snapshot. The central bank has performed three reverse repos since last week, and the one yesterday was the largest so far.
Liquidity in the banking system in China is also affected by money flow in and out of the country. As we have explained many times, that trade surplus and capital inflow force the PBOC to intervene in the FX market by creating RMB and buy USD, and that create excess liquidity in the Chinese banking system that the PBOC would have to sterilise it (RRR appears to be one of the preferred way by the PBOC to lock up liquidity). As trade surplus shrinks to lower levels and as capital flow becomes unfavourable, liquidity tightens in China if the central bank does nothing.
The chart below from Michael McDonough of Bloomberg Brief shows the recent shortage of liquidity in terms of the 7-day repo rate, along with the reserve requirement ratio (RRR) and PBOC reverse repo operation. As you can see, liquidity tightened slightly in the recent weeks, and a number of reverse repos are performed.
As debt deflation continues and the China growth story dies, monetary condition will be biased towards tighter end, all things being equal. Thus there will be a need for PBOC to inject more liquidity or to cut reserve requirement ratio. Indeed, we believe that there is a huge room for PBOC to reduce reserve requirement ratio in the future. At this moment, we would not be surprised if an RRR cut is just around the corner.