Rate cuts to spur economic growth, boost liberalization

The cut in reserve requirements should release about 700 billion yuan ($110.3 billion) in base money supply, helping to ensure adequate liquidity conditions in light of capital outflows. While the PBOC has been using alternative tools to provide liquidity, including medium-term lending facility and reverse repos, lowering RRR has the added benefit of releasing liquidity more "permanently" and anchoring expectations.

Such a move should also help lower the short-end of interbank interest rates, which can help further lowering the longer dated government bond yields. We expect another 50-100 bps RRR cut by end 2015, and about 300bps cut by end 2016. In the past, as the PBOC expanded its balance sheet along with forex reserves accumulation, it raised reserves requirements to "freeze" a large portion of the resulting liquidity. Now that the reverse is happening, the central bank can "unfreeze" the liquidity by lowering RRRs.

Looking forward, further monetary easing can help to reduce debt service burdens and improve corporate cash flows, but will be of limited use in supporting growth unless combined with fiscal measures and structural reforms.

On both fronts, the government has intensified effort in recent months in accelerating implementation and funding of infrastructure as well as announcing price reform and deregulations to help support growth. We expect recent policy effort to help stabilize growth in the near term (with a sequential rebound in Q4) and offset the increased downward pressure from adjustment in the property and industrial sectors.

The article is written by UBS economists led by Wang Tao. The views do not necessarily reflect those of China Daily.