[EGG-TALK] China’s Reserve Requirement Cut: Key Economic Impacts

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(PBOC) has lowered the reserve requirement ratio (RRR), drawing significant attention to its ripple effects across the economy.

This decision is a measure aimed at stimulating economic growth, and it could have substantial impacts not only within China but also on the global economy and financial markets.

Since the onset of the COVID-19 pandemic, the PBOC has continuously reduced the RRR (a total cut of 100 basis points in March 2023, September 2023, and February 2024). With this latest 0.5 percentage point reduction, the central bank will inject long-term liquidity worth 1 trillion yuan (approximately 189.4 trillion KRW).

As the RRR has a significant influence on the global economy, let’s take a closer look at the reasons behind this cut and its potential impacts.

Meaning and Background of the People’s Bank of China’s Reserve Requirement Ratio (RRR) Cut

The reserve requirement ratio is the minimum percentage of funds that banks must hold in reserve. Lowering this ratio increases the money supply and allows banks to lend more funds.

This is a measure to enhance liquidity, and the Chinese government has made this decision to stimulate the economy.

The reason for implementing such a policy is the disruption of global supply chains following the COVID-19 pandemic, which severely impacted China’s export-driven economy.

Moreover, China’s real estate market is facing a crisis due to the debt issues of major property developers like Evergrande, resulting in a significant drop in consumer confidence.

Economic instability has led to a general slowdown in economic growth, prompting the government to recognize the need to increase liquidity as a way to address these challenges.

The Impact of Lowering the Reserve Requirement Ratio on the Chinese Economy

♧Positive Aspects

1. Increase in Consumption and Investment : The expansion of liquidity leads to a reduction in bank lending rates, which can lower the cost of financing for businesses and individuals. This can promote consumption and investment, aiding in economic recovery.
2. Stabilization of the Real Estate Market : The provision of liquidity to respond to the real estate crisis can contribute to market stabilization and have a positive impact on homebuying sentiment.

♣Negative Aspects

1. Worsening Debt Problems : The lowering of the reserve requirement ratio in China makes it easier for businesses to obtain loans, but it could worsen existing debt issues. In particular, the real estate sector and local governments are already burdened with high levels of debt. While the increase in liquidity may alleviate short-term funding difficulties, it poses a risk of greater long-term debt burdens. If debt repayment issues arise, it could trigger a crisis throughout the Chinese economy.
2. Increased Inflation Pressure : With the increase in liquidity due to the lowering of the reserve requirement ratio, consumption and investment may rise, potentially triggering inflation. Especially if there is a surge in consumer spending in the domestic market, the pressure on prices is likely to increase significantly. If price rises become excessive, it could strain the economy and prompt the central bank to implement tightening measures again.

Impact on Various Economic Indicators

1. Increase in Crypto Market Capitalization : The increase in liquidity resulting from the lowering of the reserve requirement ratio encourages investors to allocate more funds into stocks and cryptocurrencies. This is likely to boost the overall market capitalization of the crypto market. In particular, significant upward trends are expected for major cryptocurrencies like Bitcoin and Ethereum.
2. Rise in Consumer Price Index (CPI) : As liquidity increases, consumer spending is expected to rise, leading to higher prices. Notably, price increases in essential consumer goods and services are anticipated, which could exacerbate inflationary pressures across the economy.
3. Changes in Unemployment Rate : With businesses being able to secure more funding, job creation is expected to increase. This is likely to lead to a reduction in the unemployment rate, with small and medium-sized enterprises playing a crucial role in creating jobs.

Future Outlook: China’s Financial Policy and Market Prospects

1. Additional Interest Rate Cuts : Following the lowering of the reserve requirement ratio, it has been announced that the interest rate on 7-day reverse repos will be reduced from the current 1.7% to 1.5%, a decrease of 0.2 percentage points. Pan Gongsheng, the Governor of the People’s Bank of China, also indicated that the Loan Prime Rate (LPR) and deposit rates are expected to be lowered by 0.2 to 0.25 percentage points.
2. Price Stability and Inflation : As the supply of funds increases, there are concerns about rising consumer prices in the short term. However, it will be crucial to maintain the inflation target under the control of the central bank. Therefore, a proper combination of interest rate policy and fiscal policy will be necessary.

With the People’s Bank of China’s reduction in the reserve requirement ratio, it is time to observe whether this will improve the prolonged economic slowdown in China and positively impact the global economy.