RRR cut still in country’s best economic interest

Recently, an argument has been put forward that, with yuan funds outstanding for foreign exchange on the rise and the recent issuance of reverse repurchase agreements by the People's Bank of China (PBC), the country's central bank, another cut in banks' reserve requirement ratio (RRR) will not be necessary to stimulate the nation's slowing economy.

In March, the total balance of the yuan fund outstanding for foreign exchange - that is, yuan issued by the central bank to buy foreign currency that flows into the country - stood at 25.6 trillion yuan ($4.05 trillion), up 125 billion yuan from February, according to statistics released by the central bank on April 24. This increase in March was more than five times higher than gains seen in the previous month. Also, last week, the PBC offered 65 billion yuan ($10.4 billion) of seven-day reverse repurchase agreements to select banks.

With the capital from these two channels, plus an additional 250 billion yuan worth of bills and repos due to reach maturity in May, the market stands to see a total injection of 440 billion yuan by the end of this month - far more than a 0.5 percent RRR cut could offer, many are claiming.

While it might not seem necessary in the short term, over the long haul China definitely needs another RRR cut to increase liquidity and cope with flagging economic growth.

For one thing, the central bank's reverse repos, which have a short-term maturity period, will only temporarily ease liquidity and cannot replace the long-term benefits of an RRR reduction. Earlier this year, in fact, the PBC slashed the RRR in February, just weeks after offering a round of reverse repos in January, signaling the need for a multi-faceted approach to China's credit woes.

Furthermore, increases in the yuan funds outstanding for foreign exchange will not go far enough to take the pressure off the market's current credit crunch. In the first quarter, yuan funds outstanding for foreign exchange only totaled 289 billion yuan, according to the Xinhua News Agency, down 74 percent compared with the same period last year. Thus, even if the PBC chopped 1 percent off the RRR, which could bring about 800 billion yuan into the market, liquidity would still be tighter than last year.

Making matters worse, growth in the balance of yuan funds outstanding for foreign exchange is also expected to decline in the coming months, as the country's gloomy export outlook batters the yuan's exchange rate.

According to statistics from last week's China Import and Export Fair, also known as the Canton Fair, the largest trade event of its kind in China, the value of the country's export deals for the spring season declined for the first time in nearly three years, dropping 4.8 percent compared with autumn 2011. With 86 percent of the orders inked at the fair being for short-term deals, low buyer confidence and concerns about the health of the world economy are expected to drag down demand for China's exports into the near future.