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In 2024, the central bank implemented a strong reserve requirement ratio cut while exercising restraint in reducing interest rates.

On January 24, 2024, the President of the Bank of China announced during a press conference that the reserve requirement ratio for deposits would be lowered by 0.5 percentage points on February 5, with the injection of 1 trillion yuan of long-term liquidity into the market. Additionally, on January 25, the re-lending and rediscount rates for agriculture-related and small business loans were reduced by 0.25 percentage points. Let’s break this down and discuss whether this move is truly beyond expectations. Why wasn’t there a straightforward interest rate cut, and how should we interpret the current monetary policy situation? The more the reserve requirement ratio is lowered, the more money banks will have on hand, leading to an increase in the base money released into the economy.

The central bank announced for the first time in history through a press conference, instead of leaving people guessing and speculating. By clearly issuing a preview, they are deliberately strengthening expectation management. The second point is that the magnitude of the adjustment is not small, with a 0.25 percentage point increase in both 2022 and 2023. The incremental continuation of MLF is a very restrained monetary easing measure. Now they are directly doubling down, so who is this large amount aimed at?

Firstly, looking at the timing of the rate cut on February 5th, with the Chinese New Year on February 10th, it is clear that this is to deal with the large curve settlements before the holiday, giving banks more money to handle the situation. This timing is not surprising. Secondly, by loosening the restrictions on banks, it is said that banks cannot survive without profits. It’s like giving an umbrella on a sunny day and taking it back on a rainy day. They have no choice but to engage in the traditional banking practice of borrowing low and lending high to earn interest spreads. However, in the past year, banks have also had a tough time. As of the end of the third quarter last year, the net interest margin of commercial banks had dropped to 1.73, reaching a historical low. This has been below the prudent level of 1.8% for several consecutive quarters.

Although there was a wave of interest rate cuts at the end of last year, it did not change the trend of companies depositing funds in fixed-term accounts. It is still difficult to lend out money, as the interest rate spread has not improved. Further lowering the loan interest rates is unsustainable, which is one of the reasons why the interest rate cut in January failed. The bonuses that were previously issued can still be recovered and paid out. With resources in hand, there is no need to panic. It is absolutely crucial for banks to avoid any issues. According to a report from Citic Securities, in December last year, the outstanding balance of Medium-term Lending Facility (MLFU) had reached a staggering 7.08 trillion yuan. However, it is important to note that MLF is a medium-term loan that needs to be repaid after one year. This results in the bank’s liabilities being skewed towards the short term. Additionally, with the issuance of 1 trillion yuan in government bonds and 1.5 trillion yuan in special refinancing bonds, banks need to spend money to purchase them. This means that the current liability structure of banks is unstable. The purpose of releasing these funds to banks is to improve their liability structure and address the issue of curve issuance of bonds and various expenses that require funding.

The third quarter prices are not rising, with low nominal interest rates but high real interest rates. The biggest change last year was that many industries were caught in a price war. Demand recovery lagged behind production capacity, leading to reduced demand, lower profits for businesses, fewer job opportunities, reduced wages and benefits, lower incomes, and subsequently reduced consumption. With decreased consumption, businesses faced even lower profits, creating a vicious cycle. In January, the National Bureau of Statistics announced that prices of 32 out of 50 important production materials in circulation fell in the first half of the month, increasing to 39 in the second half. This situation highlights the concept of real interest rates, which can be calculated by subtracting the year-on-year CPI growth rate from the policy interest rate. Despite low nominal interest rates, the negative CPI growth rate results in high real interest rates. In simple terms, although interest rates for loans to residents and businesses are low, they are still hesitant to borrow due to low prices and weak demand. Without the incentive to expand production or consumption, it feels like a losing proposition. This inaction creates a dilemma for monetary policy, as the economy relies on a cycle of mutual support where everyone needs to participate for it to function effectively.

The summary of Huachuang Macro’s report is very accurate. A high real interest rate means that the current domestic investment expansion incentive is not strong enough, and there is a need to expand credit. However, a low nominal interest rate also means that the attractiveness of foreign assets is too weak. Every time the cost is reduced by nominal interest rate cuts, it objectively creates pressure on the exchange rate. It is necessary to expand credit while stabilizing the exchange rate. Looking back at what has happened recently, it is clear that the market was expecting a rate cut. People thought that the rate cut in December last year was paving the way for further cuts. You all thought there would be a cut, so there is no need to talk about it because it’s inevitable. The recent actions in Jiangxi have been minimal, just adjusting the targeted reserve requirement ratio and rediscount rate to provide banks with enough funds to cope with the pressure on interest rate spreads, deal with the surge in credit at the beginning of the year, and respond to the development of the yield curve. In essence, it is about managing liquidity. The reduction in nominal interest rates remains very restrained. Therefore, all the headlines about unexpected moves and major announcements in the past few days are not really surprising. This is consistent with our previous discussions on the direction of monetary policy. There will not be strong stimulus measures. It’s just playing the cards they have. Can this be considered unexpected? It’s completely within expectations.

The prices are not going up, but the real interest rates are still high. Even if the nominal interest rates are lowered, the impact is limited. In other words, there is not much room for maneuver. So, what can be done? Other tactics can be used to leave more money with the banks to cope with liquidity shocks. By lowering the bank’s liability costs through intelligence and rediscount rates, the adjustment of the LPL can be promoted. Although the reduction is not significant, the purpose can still be achieved without simply and crudely lowering the MLF policy rate. For the transformation of urban villages and the dual-use of affordable housing ratings, the three major projects are supported by PSL. You can check that the balance of PSL has significantly increased. This time, a more relaxed commercial property loan was specifically proposed. In the past, commercial property loans, such as using shopping malls owned by real estate companies for financing, could only reach up to 30%, rarely exceeding 50%. This time, it can be increased to 70% of the property appraisal value, which is beneficial for companies like China Resources, Wanda, Longfor, and New Town Holdings that own shopping malls. However, they have already maxed out their mortgages, so it may not be very useful. When will the real interest rate reduction space be opened up? It was clearly stated at the press conference that the shift in the Federal Reserve’s monetary policy is favorable for us to expand the operational space of monetary policy. Before the Federal Reserve reverses its interest rate cut, the difficult choice of internal and external balance may continue. This is already the optimal choice under the pressure of internal price and external asset. Just think about it, under the strong dollar cycle, pushing for moderate price increases, expanding employment and income, can these be solved by monetary tools? The next step is to wait for the improvement of the overseas environment. As for whether there will be any action by the Federal Reserve in March, no one dares to say. But one thing is certain, in 2024, the probability of loose monetary policy across the ocean is much stronger than the severe environment in 2023. At the press conference, there was a statement that financial policy should coordinate and cooperate with other policies. This is a more macro issue that goes beyond the financial scope. This statement is worth pondering.

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