Morgan Stanley weighs in on the much-talked about raising of the Chinese reserve requirement ratio.
The take of analyst Manoj Pradham? Contrary to what people around the world assumed, the People’s Bank of China isn’t really tightening at all — just managing liquidity.
Which measure of liquidity? To correctly interpret whether
central banks are really tightening policy or simply managing
liquidity, it is important to distinguish between funds within the
banking system and those that are available to private
individuals and institutions in the real economy (see “Liquidity
Liquidation?” The Global Monetary Analyst, January 27,
2010). When central banks drain an excess of funds within
the banking system, the operations usually leave behind
sufficient funds for the smooth functioning of interbank
borrowing/lending. There is therefore little impact on the cost
of funds for banks and consequently very little impact on the
real economy. It is when policy rates are raised that the real
economy is affected. Viewed from this perspective, it is clear
that excess funds, if allowed to stay within the banking
system, would in fact keep putting downward pressure on
interbank lending/borrowing rates.
may simply be postponing the macro problem. Banks
could move excess reserves into the real economy
rather than back into reverse repos and term deposits.
Policy tightening, when it begins, will still keep policy
rates below neutral for all of 2010, keeping liquidity
ample, abundant and augmenting.
RRR hikes by the PBoC are similar in spirit to the RR
operations expected from the Fed: The second RRR hike
by the PBoC falls into the liquidity management category.
According to our China economist, Qing Wang, the RRR
hikes have been instituted in response to strong export growth
and ensuing capital inflows (see page 12) that led to a rise in
excess reserves (see Exhibit 1). The PBoC action should not
be seen as having occurred despite a stable ratio of excess to
total reserves, therefore implying a policy tightening. Rather, it
is because of central bank draining operations – RRR hikes
included – that the ratio is stable. Imagine if ER at the Fed
had been stable after QE – one would have to assume that
the Fed had been draining these reserves. And just as early
draining of reserves at the Fed will not constitute outright
policy tightening, the PBoC’s RRR hike is almost entirely
about draining funds from within the banking system.
Photo: Morgan Stanley