China’s top executive body, the State Council, has said the country’s central bank might cut the reserve requirement ratio (RRR) -- the amount of funds banks need to hold -- in order to stimulate the economy.

“China will use monetary policy tools, including RRR cuts, in a timely way to further step up financial support for the real economy, especially small firms," the council said on July 7 after a meeting chaired by Premier Li Keqiang.

Cutting the RRR would free up more cash from People’s Bank of China (PBOC), allowing banks to lend more, especially to the small and medium enterprises (SMEs) ,“to help them cope with rising commodity prices.”

The monetary policy will be kept stable while increasing its effectiveness, but the government will not resort to "flood-like" stimulus, the council said.

PBOC Deputy Governor Fan Yifei said they would continue to guide financial institutions to increase lending to more SMEs, lower the market loan interest rates and reduce the payment processing charges.

Analysts see the signalling by China, which has “taken the market by surprise,” as revealing new pressures facing the economy in the coming months.

However, they do not expect another large-scale monetary easing cycle. The policymakers’ latest move would not have as much of an impact on bigger companies as the smaller ones, which are hardest hit by rising cost of raw materials, as per a South China Morning Post report.

A day after the announcement, Lu Ting, chief China economist at Nomura, said in a note that a shift to some kind of policy easing in the second half of the year would be no surprise. “But using a high-profile tool such as the RRR cut is a big surprise to markets and us,” said Ting, who estimated a cut of 0.5 percent in the coming weeks.

The PBOC had cut the RRR thrice in the first four months of 2020, releasing around 1.75 trillion yuan as part of its 9-trillion-yuan package to fight the COVID-19 pandemic and provide support to the economy.

Economic data for last month and second quarter gross domestic product are due by July 15.

Impact on India and World Markets

As China's economy is the world's second largest, any policy change is likely to affect the global markets.

Its signal of easier monetary policy also comes at a time when the United States Federal Reserve is considering plans to tighten policy, gradually moving away from stimulus measures taken in the wake of the COVID-19 pandemic.

At present, it is slowing from a record 18.3 percent expansion in the first quarter, when the reading was considered highly skewed when compared with early 2020.

Earlier this year, World Bank Group President David Malpass had called for “a major push to improve business environments, increase labour and product market flexibility, and strengthen transparency and governance” to “overcome the impacts of the pandemic and counter the investment headwind.”

According to a report by JPMorgan Chase & Company, the low correlation between Chinese and foreign bond markets provides the benefit of diversification.

The report said China’s domestic industry policies, riding on carbon neutrality, have affected commodity prices. “These policies/initiatives have probably led to expectations of lower domestic production and added upside pressure for global commodity prices.”

Now with the RRR cut, the pressure on commodity prices might decrease, giving a breather to global markets.

Also, China being among the top exporters of several commodities, a decrease in their prices would be a welcome change to the global as well as Indian markets struggling with inflation.

(Edited by : Shoma Bhattacharjee)

First Published:Jul 9, 2021 5:47 PM IST