Chinese stocks rise on bank reserve ratio cut

Chinese equities jumped in early morning trade on Thursday after the People's Bank of China loosened policy earlier than anticipated during London trading hours on Wednesday.

China's central bank cut the required reserve ratio for its banks as it stepped up efforts to counter the impact of capital outflows and encourage banks to boost lending amid fresh data showing a weakening economy.

The Shanghai Composite jumped 2.3 per cent at the open on Thursday, while Hong Kong's Hang Seng index rose 1.4 per cent.

The Hang Seng Enterprises Index - a measure of Hong Kong-traded companies based in China - climbed 2.7 per cent.

A survey published on Sunday revealed that China's manufacturing sector - a key growth driver - contracted in January for the first time in more than two years. This followed news last month that China experienced its weakest GDP growth in 24 years last year.

In addition, China suffered its largest capital outflow on record in the fourth quarter last year, according to balance of payments data released on Tuesday. The deficit of $91bn on the capital and financial accounts was the worst since quarterly data were first compiled in 1998. China's foreign exchange reserves also fell as investors sold renminbi and bought foreign currency.

"The most important reason for the cut is liquidity demand in the banking system," said Haibin Zhu, chief China economist at JPMorgan in Hong Kong.

"Forex reserve accumulation - which is traditionally an important channel to create base money - is no longer there. That creates a permanent liquidity gap that needs to be filled."

The required reserve ratio, known as the RRR, specifies the portion of a commercial bank's deposits that must be held on reserve at China's central bank, where it is unavailable for loans and other investments.

For most of the past decade, "twin surpluses" on both the current and capital accounts swelled China's foreign exchange reserves and its domestic money supply. In response, the People's Bank of China (PBOC) raised the RRR steadily as a way to sterilise these inflows and prevent inflation. The RRR for China's biggest banks rose from 8 per cent in 2005 to a high of 20.5 per cent in late 2012.

Wednesday's cut of 0.5 per cent brings that rate down to 19.5 per cent - although this is still much higher than any other major economy. With inflows now reversing, economists expect at least one more RRR cut this year.

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The central bank's latest easing move followed a cut in benchmark interest rates in November and a series of targeted easing measures last year, which included direct loans worth more than $80bn to specific banks, and RRR cuts for small lenders.

In addition to Wednesday's broad-based cut, the PBOC announced further targeted cuts for so-called city commercial banks, whose loan books tilt towards small business and the agricultural sector - two areas that have long complained of difficulty obtaining credit.

In addition to responding to domestic conditions, economists say the PBOC's move is also a reaction to moves by central banks in other countries, including the recent decision by the European Central Bank to pursue an ambitious programme of quantitative easing.

"Various countries are raising the stakes when it comes to monetary policy easing," said Cao Yang, an analyst at Shanghai Pudong Development Bank. "China's RRR cut is a move to keep pace."

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