China acts to boost loans, bolster flagging economy

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China's central bank cut the amount of cash that banks must hold as reserves on Saturday, freeing an estimated 400 billion yuan for lending to head-off the risk of a sudden slowdown in the world's second-largest economy.

The People's Bank of China delivered a 50 basis point cut in banks' reserve requirement ratio (RRR), effective from May 18, the third cut in six months and one that investors had called for after data on Friday showed the economy weakening, not recovering, from its slowest quarter of growth in three years.

Industrial production weakened sharply in April and fixed asset investment - a key growth driver - hit its lowest level in nearly a decade, surprising many economists who thought Q1's 8.1 per cent annual rate of growth marked the bottom of a downswing and were expecting signs of recovery in Q2 data.

"The central bank should have cut RRR after Q1 data. It has missed the best timing," Dong Xian'an, chief economist at Peking First Advisory in Beijing, told Reuters.

"A cut today will have a much discounted impact. So the Chinese economy will become more vulnerable to global weakness and the slowing Chinese economy will in turn have a bigger negative impact on global recovery. Uncertainties in the global and Chinese economy are rising," he said.

The domestic production and investment data had followed hot on the heels of weaker than forecast trade data, with the annual rate of export growth around half the level expected and growth in imports grinding to a halt on a nominal basis in April, underlining China's vulnerability to weakness in global demand for goods produced in the country's vast factory sector.

Bank lending in April was also sharply below forecast at 681.8 billion yuan, missing the 800 billion consensus call and raising doubts about whether Beijing had policy settings slack enough to keep the economy expanding.

"It confirms our view that the economy was not able to sustain its momentum on current policy and policy needs to be loosened," said Ken Peng, an economist with BNP Paribas.

"The fact that it waited so long meant it could have been responsible for the poor data in April. This sends a very positive signal that policymakers are accommodative."

FURTHER LOOSENING FORECAST

The cut of RRR to 20.0 per cent from 20.5 per cent for big banks still has analysts forecasting another 800 billion yuan's worth of cuts to have been earmarked for the rest of the year.

The central bank announced its first cut in RRR in three years on November 30 last year. That move took the rate down from a record 21.5 per cent. The second cut in this easing cycle was delivered in February.

Lowering RRR for banks helps China offset sluggish capital inflows that have been hit by skittish investors wary of investing their funds in higher-risk emerging markets at a time of global economic uncertainty driven mainly by Europe's festering debt crisis.

Crucially, an RRR cut would help Beijing meet its target of growing money supply by 14 per cent in 2012. Data on Friday showed annual M2 money supply growth running at just 12.8 per cent in April.

China's bank lending had trumped forecasts to spike to 1.01 trillion yuan in March, a sign of fresh traction in Beijing's bid to boost credit creation to support the cooling economy.

The surge in lending was the biggest monthly extension of credit since January 2011, when new loans last topped 1 trillion yuan, holding out hope that China's economy would not only avoid a hard landing but pick up speed again later this year.

Chinese leaders, however, are wary about inflation risks given rising global commodity prices and remain determined to cool down the property sector to ward off a speculative bubble.

The deep-pocketed government has also cut taxes for small firms, which are vital for generating economic growth and jobs, to help them cope with a credit squeeze and weaker exports.

But the bigger problem for the economy may not be the supply of credit but demand for it, given that the European Union - China's single biggest export market - is battling recession again, consumers in the United States are still paying down debt and China's domestic demand is looking limp.

That implies to some that policy has to become looser still.

"The problem is corporate loan demand is very weak right now, so the cut is not as good as an interest rate cut, since reducing banks reserves doesn't change the price of loans," said Liu Junyu, a money market analyst at China Merchants Bank in Shenzhen.

"If the economy continues to be sluggish, it is very likely that the government will choose to cut interest rates."