Why central bank downgrades the reserve ratio at this moment?

As I mentioned in last blog, Chinese central bank decided to cut the bank deposit reserve ratio over again by 0.5% since last November, implemented from Feb 24, 2012. After this adjustment, large financial institutions’ deposit reserve ratio will drop to 20.5% while the small ones will be as lower as 17%.

The reserve requirements are the amount of money and liquidity assets which banks must hold in cash or on deposit with the Federal Reserve System, usually a specified percentage of the demand deposits and time deposits. This is also the holding deposits saved in central bank to guarantee the customers withdrawing money, clearing and financial settlement. According to the central bank’s report last year, China’s RMB deposit balance was 80.9 trillion Yuan (8.09 trillion pounds), based on this, the money released by this cut was about 40.45 billion pounds.

Back to the title question, in my point of view, the reasons are as follows:

1) This is CB’s adjustment for fine-tuning and presetting monetary policy. As I have talked in last blog, because the macroeconomic indicator is not optimistic for months, many indices are quite low. In order to keep stable economic growth and economic environment, government should take this adjustment.

2) New loan scale in January was much lower than expected. This was mainly due to some small and medium-size banks have a tight liquidity and inadequate capital requirement situation. Decreasing the ratio can increase the liquidity of funds.

3) Aggressive easing of monetary and credit policy can prevent hard landing of real estate market. As the increasing liquidity will tend to release some money to the real estate market, this fills the cash flow gap and helps dampen price pressure.

In addition, Of the Central University of Finance and Economics Professor Tian Yong, Guo (2012) said, at present, Chinese macroeconomic dilemma of liquid expansion is induced by funds outstanding for foreign exchange reserves. In the context of foreign exchange reserves jumped and large amount of foreign capital flowed in, that would let the funds outstanding for foreign exchange enhance. If the RMB exchange rate levels remain unchanged, the rise will increase inflationary pressures. On the other hand, since the less optimistic situation in Europe, reduced trade surplus, the decline in foreign exchange, making the future market liquidity continues to tighten up the possibility of existence. Alternatively, it is the large holding foreign exchange hedged and the high growth rate of M2, wide currency that is the further development of RMB.