China's latest easing move a response to 'money outflows'- Nikkei Asian Review

February 12, 2015 12:00 am JSTChina's latest easing move a response to 'money outflows'KENJI KAWASE, Nikkei deputy editorBANGKOK -- The People's Bank of China's announcement Feb. 4 that it will further relax monetary policy, after slashing its benchmark interest rates last November, was widely anticipated by economists. The world's second-largest economy has been showing signs of slowing.The move by China's central bank to cut the reserve requirement ratio for all banks by half a percentage point for the first time since May 2012 will add liquidity to the financial system, boosting the economy and helping meet cash demand for the Lunar New Yearholidays. But this round of easing is seen more as a response to recent money outflows. Its stimulative effect is likely to be limited and more aggressive easing is expected later in the year.Kevin Lai, an economist at Daiwa Capital Markets in Hong Kong, says the move is "reactive, notproactive, and mainly to cope with an acceleration in money outflows." He estimates the cut in thereserve requirement will release about 600 billion yuan ($96 billion), which roughly equals thecapital outflow of $91 billion during the last quarter of 2014, according to Chinese balance ofpayment data released just a few days before the central bank's decision. "There is virtually no newliquidity creation" from the step, Lai said.Running in placeFitch Ratings shares that view. The rating agency estimates about 570 billion yuan will be freed up,which simply matches the capital outflow. The reserve requirement cut, therefore, "is less of apolicy easing than it appears. ... The measure compensates almost exactly for liquidity destroyed bycross-border capital outflows," according to Fitch.Lu Ting, China economist at Bank of America Merrill Lynch, does not see the cut as a bigstimulus because foreign currency purchases by Chinese monetary authorities dropped by a sharp129 billion yuan in December, "due both to capital flight and rising [foreign exchange] holdings inChina." To keep the exchange rate under control, the central bank regularly mops up foreigncurrency entering into the system. This "conventional channel of liquidity supply" is shrinking,according to Lu. With China's weaker growth prospects easing upward pressure on the yuan, astuteinvestors seem to be slowly pulling funds out of China.The cut in the reserve requirement did give Chinese stocks a lift, with prices jumpingimmediately following the announcement, especially in banking and real estate sectors on Feb. 5. But the rally was short-lived. The benchmark index in Shanghai fell by the close of trading, reflecting the deteriorating growth momentum of the Chinese economy. And capital outflows show no sign of halting.Kindest cut of allThe market expects more easing ahead. Hua Changchun, an economist at Nomura International (Hong Kong), said the reduction in the reserve requirement is "just the beginning." In addition to the large capital outflows and strong deflationary pressure stemming from weaker demand, there are "deeply rooted structural challenges, such as the high local-government debt burden, the continued property market correction and deleveraging."In order to tackle these problems, Hua predicts three more reductions in the reserve requirement by the end of the year and a cut in the benchmark interest rate between April and June. Hu Yifan of Haitong International Securities Group goes further, predicting three to four cuts in the reserve requirement, and one to two interest rate reductions in 2015. She also says monetary authorities will use other "unconventional tools" such as short-term liquidity operations and a medium-term liquidity facility, which were introduced last fall, to deal with the liquidity shortage.Daiwa's Lai is also betting on more easing, forecasting one more reduction in the reserve requirement and two interest rate cuts by September. However, "if the pressure on money outflows and currency depreciation becomes too much," he expects the Chinese central bank "may have to stop easing and revert to tightening."Capital flight in China is happening before the U.S. has moved to raise interest rates. The strong January U.S. job data released Feb. 6may spur the Federal Reserve to tighten sooner than expected. That will also affect China's calculations.PrintCopy right © 2015 Nikkei Inc. All rights reserv ed.。