Monetary policy supports stabilizing the market and expectations

Editor's note: Liu Qiang is a research fellow at the Academy of Financial Research, School of Economics of Zhejiang University of China. Chen Shuaidi is a research fellow at Alibaba Business School of Hangzhou Normal University of China. The article reflects the authors' opinions and not necessarily the views of CGTN. It has been translated from Chinese and edited for brevity and clarity.

To enhance the effectiveness of financial support for the real economy and achieve stable growth, expectations, and markets, the People's Bank of China implements a new round of reserve requirement ratio (RRR) cuts starting from May 15, 2024. This policy adjustment is expected to provide over 1 trillion yuan ($138.7 billion) in long-term liquidity to the market. 

The adjustment has dual objectives: first, to provide long-term liquidity to the market by optimizing the efficiency of financial resource allocation, with a focus on financing needs in key areas such as major national infrastructure projects, inclusive finance, small and medium-sized enterprises (SMEs), real estate, and the consumer market; second, to improve the deposit reserve system for automobile finance companies and financial leasing companies, thereby enhancing the level of automotive consumer finance and equipment leasing services. This demonstrates the flexibility and forward-looking nature of monetary policy in navigating complex domestic and international environments.

Stabilizing the market: Reducing financing costs in the financial system

The RRR cut directly reduces pressure on the liability side of banks by optimizing their liability structure. It lowers reliance on interbank financing, stabilizes net interest margins, and enhances banks' ability to withstand risks. Simultaneously, the increase in long-term funding supply enables banks to more consistently issue medium- and long-term loans, thereby supporting the real economy. With stable financial support, enterprises are able to improve their operational conditions, enhance repayment capacities, and reduce the risk of non-performing loans (NPLs), thereby bolstering the overall stability of the financial system.

Stabilizing expectations: Adjusting the market liquidity structure

By reducing the scale of short-term, high-cost tools such as medium-term lending facility (MLF) and reverse repos, and increasing the supply of long-term funds, the central bank effectively alleviates the term mismatch issue in financial markets and reduces liquidity risks. More importantly, this structural adjustment precisely aligns with the long-term financing needs of the real economy, effectively addressing the risk of "short-term funds for long-term use." It facilitates the efficient flow of capital to key sectors and weak links, thereby improving the efficiency of financial resource allocation.

Stabilizing Growth: Targeted empowerment of key sectors

The central bank has implemented "zeroing" RRR cuts for automobile finance companies and financial leasing companies, enabling these institutions to increase investments in areas such as automotive consumption and equipment renewal. This policy opens up credit channels for automotive consumption and equipment upgrading. By injecting structured liquidity into targeted sectors, the policy fosters the concentration of financial resources in emerging productive sectors like smart manufacturing and green technologies, stimulating the momentum for industrial upgrading.

Stabilizing development: Building a risk buffer mechanism

The RRR cut helps reduce the space for non-bank institutions' capital rotation and arbitrage, effectively guiding funds toward the real economy. Moreover, relying on the central bank's stable long-term liquidity supply, it reverses the short-term operational tendencies of commercial banks, securities firms, and other financial institutions. Policy guidance encourages market participants, such as manufacturing companies and technology firms, to make more prudent long-term investment decisions. This central bank-led expectation management mechanism not only establishes a solid risk buffer for the financial system but also reduces market volatility caused by monetary policy adjustments. This enables securities regulators to effectively curb irrational speculative behavior, providing a solid foundation for the stable operation of financial markets.

Boosting confidence: Smoothening the transmission of monetary policy

The RRR cut enhances the money creation function and leverages a greater money multiplier effect. Firstly, it accelerates credit flows to key areas such as major national infrastructure projects, inclusive finance, small and medium-sized private enterprises (SMEs), real estate, and the consumer market. Secondly, it strengthens the supply of funds for stock and bond markets, supporting fiscal expansion and large-scale government bond issuance. Thirdly, it alleviates liquidity pressures faced by some private enterprises, real estate companies, small financial institutions, and local governments. Overall, the RRR cut, through the transmission of monetary policy, results in a stable reduction in comprehensive financing costs across society, boosting market confidence and effectively supporting the stable growth of the real economy.

Looking ahead, the benefits released by this RRR cut will continue to transform into a driving force for the development of the real economy. As emerging productive sectors such as smart manufacturing and the green economy receive financial support, the upgrading of both industries and consumption will accelerate. Under the "stabilizing growth, stabilizing expectations, and stabilizing markets" framework, China's financial market will contribute to global economic growth through a "Chinese financial solution" that combines both stability and innovation.