On January 4, China's central bank, the People's Bank of China (PBOC) announced on its official website that it would reduce commercial banks' reserve ratios (RRR) in an effort to increase liquidity and boost lending to small and micro-sized enterprises. The cuts will be made twice, each time by 0.5 percentage point, effective on January 15 and 25 respectively.

As the PBOC also announced that it would not roll over loans offered through Medium-term Lending Facility (MLF) that are scheduled to mature in the first quarter of this year, Wang Jianhui, general manager of R&D Department at Capital Securities, said that these RRR cuts would make sure sufficient funding is injected into commercial banks as some of them pay back their MLF loans. As a result, there will be enough lending made to small- and micro-sized enterprises to support the real economy.

Wang explained that MLF was a tool created by the PBOC back in September 2014, which offers three-month loans to commercial banks with the aim of growing the money supply. As MLF only grants a limited amount of loans in total to commercial banks and the commercial banks still have to pay the interest rate, which is higher than the banks' overall funding cost, the recent move would reduce the cost of debt for Chinese commercial lenders.

When asked about the timing of these cuts, Wang pointed to the relatively large downward pressure facing the Chinese economy. He said that when MLF was introduced in 2014, the economy was in better shape and the reasoning behind increasing liquidity was based on the economic need of deleveraging, cutting excessive industrial capacity and destocking.

However, since then, economic pressure has kept building up. As Wang pointed out, according to the Chinese National Bureau of Statistics, manufacturing activity for large Chinese companies and state-owned enterprises contracted last December for the first time in over two years, while the PMI gauge on small- and medium-sized enterprises has been below 50 percent for three and four months respectively.

Judging from the current economic status, Wang said that the issue is not likely to fade any time soon and may add uncertainties to the upcoming China-U.S. trade talks. The move to boost lending is an action taken to tackle the economic pain through increasing liquidity and increase funding methods as well as a precautionary measure responding to the economic uncertainties looming in the future.