Over the weekend the PBoC raised the bank’s reserve requirement ratio (RRR) by 50bp. This is likely to remove about RMB250b from the banks. The question is, why make such a move?
A priori it makes no sense as the government controls the loan supply by setting targets – a target of RMB 7.5tn was set for 2010 for example. In fact over the past few weeks both short-term rates and long-term yields have been heading south, the result of adequate supply and limited demand for credit. In other words this RRR increase is not a tightening measure, but simply the equivalent of issuing in central bank bonds at a lower rate (i.e. the deposit rate for required reserves is 1.62%, while the 1 year bills are about 1.93%). But we still haven’t directly answered the question as to why the RRR was raised.
Well, it looks like the PBoC’s move was intended to manage market expectations of an imminent rate rise. In recent weeks hot money has flowed into China, and foreign currency in the country has been exchanged to RMB on the assumption that the currency would appreciate. Such FX flows in combination with tightened demand for credit reduced rates at the near end of the curve. By raising the RRR the PBoC is trying to support short-term rates, which means that the banks itself does not intend an imminent rate rise.
A number of my readers have commented that they would like a beginner’s explanation of some of the topics I cover in my blog. There is a wonderful website called http://investopedia.com – a financial dictionary with tutorials and comprehensive articles. This blog entry touches on topics including money supply, the impact of interest rates, foreign exchange. Clicking on the link below will take you to a definition of the term “money supply”. There are links on the page to related terms and related articles.