Liquidity to sustain China stock rally

In the first quarter, China’s gross domestic product expanded 7 per cent, the slowest pace in six years.
Recent economic data releases have signalled alarmingly weak economic activities.
March export growth fell 15 per cent when compared to the same period last year while imports declined 12.7 per cent, implying weak domestic demand. Industrial output rose 5.6 per cent year on year in March, the lowest reading since November 2008.
Weak economic data is adding pressure on the central bank to act. People’s Bank of China (PBoC) governor Zhou Xiaochuan, admitted that China’s growth rate had tumbled a bit too much and that policy-makers had scope to respond. China’s inflation is also declining, making room for monetary-policy easing. Many economists are expecting PBoC to roll out aggressive monetary-easing policies to stem the economic slowdown. These would include interest rate cuts and reductions of the reserve requirement ratio. RRR is the minimum fraction of customer deposits that commercial banks must hold as reserves rather than lend out. High RRR, therefore, limits the amount of funds available in the economy. RRR in China remains exceptionally high at 19.5 per cent, compared to 6 per cent in Thailand.
With a massive deposit base in China, a cut in RRR would translate into a significant liquidity injection.
In practice, a RRR cut could have similar effects to quantitative easing. According to our calculation, a half a per cent cut in RRR would free up roughly US$100 billion (Bt3.2 trillion) for banks to lend.
Our research partner at Deutsche Bank expects PBoC to cut RRR by a total of 2 per cent in 2015. That would release approximately $400 billion into the economy. The amount is massive; it is roughly equal to two-thirds of the Bank of Japan and European Central Bank’s quantitative easy programmes, which amounts to $660 each.
China’s stock market has more than doubled in the past year, but it still remains one of the cheapest in the world. An additional liquidity boost from the central bank will likely keep the rally going further.

Komsorn Prakobphol, the author, is head of strategy at the Tisco Economic Strategy Unit.