The document discusses China's reduction in its reserve requirement ratio (RRR) to boost its slowing economy. It provides background on RRR and its role in China's monetary policy toolkit. While RRR cuts could increase inflation, speculation, and currency depreciation, current data shows inflation is low and economic growth has slowed, making RRR cuts necessary. The cuts will increase money supply and lending to stimulate the economy. Stock markets may rise in the long run due to improved economic expectations. RRR cuts are an effective policy given China's current economic conditions.

1. He Jiang
Reduction in Reserve RequirementRatio in China
China has experienced a outstanding economic growth after the "reform and
open-up policy". However, according to the data from the World Bank, China's GDP
growth rate began to slow down after the year 2007. In the first quarter of 2015, the
GDP growth was 7% which is the lowest growth rate in the last 6 years. In order to
boost China's economy, China's central bank(PBOC) made several cuts in
RRR(Reserve Requirement Ratio) since 2012. The cuts in RRR allow commercial
banks to lend more money to businesses and increase the money liquidity in the market.
OnSunday April 20th, PBOC announced to cut the RRR by 1% which is the biggest cut
since December 2008. This paper analyzes how will the RRR cuts affect China's
economy from the financial, stock market, real estate market as well as currency
exchange rate perspectives.
History and Importance of RRR
Reserve Requirement refers to the minimum fraction of consumer deposits and
notes that each commercial bank must hold as reserve. Tito Cordella points out that
RRR has been used fairly frequency as a macroeconomic stabilization tool especially
for developing countries. And it also a useful tool to smooth out the business cycle1.
1
Cordella,Tito,andEbooksCorporation.Reserve Requirementsinthe Brave New

2. China began to use RRR policy to adjust the economy since the year 1984. In China,
RRR and Interest rate are the two powerful tools used by the central bank (PBOC) to
maintain the value of currency and to stabilize the economic growth.
RRR and CPI
In China, one of the most important roles of RRR is to be the inflation fighting tool.
The increase in RRR could reduce the money supply in the market, and the reduction in
money supply will contribute to the control of CPI. Therefore, two of the biggest
questions concerned by Chinese economists are whether the cuts in RRR will increase
the CPI and whether it will result in the speculation in real estate market.
One of China's economists Yu argues that China's current economy exposed
several potential problem including overheated economy and the increasing of
inflationary pressure2. However, according to the data from the World Bank (Chart 1),
the annual GDP growth in China began to decline since the year 2007. Therefore, the
economy has already been slowed down, the overheated economic period has already
passed. Meanwhile, China's RRR began to cut since the year 2012. By contrast, U.S.
has been used a very loose monetary policy since 2009. The interest rate in U.S. is even
close to zero. By comparing the annual GDP growth in China and U.S., we could see
that there has been a very well recovery in U.S.'s economy since 2009. By contrast,
Macroprudential World.Washington,D.C:The WorldBank,2014
2
Dong Yu, Researchonthe effectof depositreserve rate change onstockprice andlisted
commercial banksin China,Liaoning:OceanUniversityof China,2012

3. China's has experienced a downtrend economic growth rate since 2007 under its
tightening monetary policies. Under the current situation, there is no need for China to
control the overheated economy. On the contrary, there has beena urgent need to reduce
RRR in order to stimulate the economy.
On the other hand, from the inflationary perspective, Chart2 is China's annual CPI
from 2008-2014. From this chart, the highest CPI occurred in the year 2011 which is
5.4%. However, the CPI began to decline since 2012. And the annual CPI for 2012,
2013 and 2014 are 2.7%, 2.6% and 2% which are all below the 3.5% CPI upper limit
suggested by the central bank. Therefore, there is no need to control the inflation in
China since there has been no such a problem since 2012. By contrast, the PPI

4. decreased by 1.9% in the year 2014 which show a signal of deflation.
RRR and Real Estate Market
Another doubt is whether the RRR cuts will result in the speculation in real estate
market. Real estate market is very money sensitive. From the historical perspective, the
changes in RRR have great effect in real estate market. But due to the home-purchase
restriction policy, the growth rate of China's housing price has a downtrend since 2008.
In the year 2011-2013, the housing price even declined. Therefore, even though the
strong RRRreduction could possibly lead to an increase in housing price, it's less likely
to cause the sharp increase since the effective police of home-purchase restriction.
In the mean while, China's current economy is urgent for recovery. It is also not
reasonable to slow down whole economic growth just to control the housing price in
big cities.

5. RRR and Financial Market
Monetary policy change can bring great influence to financial markets3. RRR is
one of the most powerful monetary tool in China. And it is seldom used by other
countries. China chose to use tightening monetary policies and controlled the credit
loans after the financial crisis. Under this situation, it's difficult for businesses to
borrow loans from commercial banks. Therefore, a lot of businesses especially small
and medium size businesses faced severe financial problem. The 1% RRR reduction in
April 2015 mean the Chinese central bank will release 1.2 trillion Yuan to the market.
After the adjustment, the current RRRs for large financial institutions and small and
medium size institutions are respectively 19.5% and 16%. This policy will allow
commercial banks to give more credit loans to businesses. Therefore, the financial
problem could be relieved to some degree.
RRR and Stock Market
3 P. Sellin,Monetary policy and the stock market: theory and empirical evidence,Journal of Economic
Surveys 15,2001

6. From the stock market perspective, Jin believes that RRR is an lagging and
unstable indicator to the stock market4. Following column is the historical data of RRR
adjustments and the one-month changes in Shanghai composite index after the
adjustments. And Chart 3 is the overall trend of Shanghai Composite Index from
2003-2015. As we can see from the column 1 and chart 4, PBOC gradually raised the
RRR from Jan. 2010 till Nov. 2011. In this period of time, even through the short-term
stock market did not fluctuate with the RRR adjustments, the overall stock market
declined from late 2010 to the mid 2012. Hence, the historical data once again prove
that in the RRR is an unstable indicator to the short term stock market. In the long run,
the overall trend of the stock market fluctuates with the RRR adjustment but several
months behind the adjustments.
In the mean while, the RRR policy could also affect people's expectations toward
the future market. That is to say the reduction in RRR would give people more
confidence towards the future economy. Therefore, it is reasonable to expect a bull
market in China several month after April 2015.
Date
Large Financial Institutions
Small & Medium Size Financial
Institution
Stock Market
(One Month)
Before
Adjustment
After
Adjustment
%
Before
Adjustment
After
Adjustment
%
Shanghai
Composite
Index
02/18/2012 21% 20.5% -0.50% 17.50% 17.00% -0.50% 0.30%
11/30/2011 21.50% 21% -0.50% 18% 17.50% -0.50% 2.29%
4 Jin,Liling.存款准备金率的调整对我国股票市场的影响[D]. Sichuan：Southwestern University of
Financeand Economics，2012.

7. 06/04/2011 21% 21.50% 0.50% 17.50% 18% 0.50% -0.95%
05/12/2011 20.50% 21% 0.50% 17.00% 17.50% 0.50% 0.95%
04/07/2011 20% 20.50% 0.50% 16.50% 17.00% 0.50% 0.22%
03/18/2011 19.50% 20.00% 0.50% 16.00% 16.50% 0.50% 0.08%
02/18/2011 19.00% 19.50% 0.50% 15.50% 16.00% 0.50% 1.12%
01/14/2011 18.50% 19.00% 0.50% 15.00% 15.50% 0.50% -3.03%
12/10/2010 18.00% 18.50% 0.50% 14.50% 15.00% 0.50% 2.88%
11/10/2010 17.50% 18.00% 0.50% 14.00% 14.50% 0.50% -0.15%
11/10/2010 17.00% 17.50% 0.50% 13.50% 14.00% 0.50% 1.04%
05/02/2010 16.50% 17.00% 0.50% 13.50% 13.50% 0.00% -1.23%
02/12/2010 16.00% 16.50% 0.50% 13.50% 13.50% 0.00% -0.49%
01/12/2010 15.50% 16.00% 0.50% 13.50% 13.50% 0.00% -3.09%
12/22/2008 16.00% 15.50% -0.50% 14.00% 13.50% -0.50% -4.55%
11/26/2008 17.00% 16.00% -1.00% 16.00% 14.00% -2.00% -2.44%
10/08/2008 17.50% 17.00% -0.50% 16.50% 16.00% -0.50% -0.84%
09/15/2008 17.50% 17.50% 0.00% 17.50% 16.50% -1.00% -4.47%
06/07/2008 16.50% 17.50% 1.00% 16.50% 17.50% 1.00% -7.73%
05/12/2008 16.00% 16.50% 0.50% 16.00% 16.50% 0.50% -1.84%
04/16/2008 15.50% 16.00% 0.50% 15.50% 16.00% 0.50% -2.09%
03/18/2008 15.00% 15.50% 0.50% 15.00% 15.50% 0.50% 2.53%
01/16/2008 14.50% 15.00% 0.50% 14.50% 15.00% 0.50% -2.63%
08/12/2007 13.50% 14.50% 1.00% 13.50% 14.50% 1.00% 1.38%
10/11/2007 13.00% 13.50% 0.50% 13.00% 13.50% 0.50% -2.40%
10/13/2007 12.50% 13.00% 0.50% 12.50% 13.00% 0.50% 2.15%
09/06/2007 12.00% 12.50% 0.50% 12.00% 12.50% 0.50% -2.16%

8. RRR and Currency Exchange Rate
Theoretically, the increase in money supply will cause the currency depreciation.
But the depreciation of RMB has to face both domestic and international pressures. On
the one hand, China has to face the large external imbalance caused by the huge export
suplus. On the other hand, the export surplus means the deficits to China's trading
partners. Since 2006, there were more than 100 cases of the anti-dumping and
anti-subsidy import restrictions on China imposed by U.S. and EU5. Indeed, U.S also
use the political power to force the appreciation of RMB. Therefore, despite there is an
increase in money supply, it's less likely to have a sharp depreciation in RMBdue to the
political pressures and the trade restrictions.
Conclusion and Policy Suggestion
RRR is one of the most powerful tools used by PBOC to adjust China's economy
from a macro level. The reduction in RRR could increase the money liquidity in the
market, help businesses relief their financial difficulties, stimulate China's current
stagnant economy and cause the raise in stock market. There might be a possible
speculation in real estate market, and the RRR cuts would give pressure to the
appreciation of RMB. But the side effects cannot even compete with the benefits it
brings. Indeed, China's current CPI is not high, there is still much space for the possible
inflation in the future. The decline in CPI indicates a good timing for the reduction. In
5 John Knightand Wei Wang, China's Macroeconomic Imbalance:Causeand Consequences,
University of Oxford,2011

9. order to quickly step off the stagnated economic condition, the reduction in RRR is
necessary and inevitable to China. To cut the RRR in China is to do the right thing in the
right time.
In the mean while, there is still a 19.5% of RRR for the large financial institutions
and a 16% for the small and medium size financial institutions which show that there is
still enough space for the future reduction. Indeed, the RRR cuts could work with the
interest rate reduction when it is necessary.

10. References:
(1) Chart 1 : Data from The World Bank
(2) Chart 2: Data from the World Bank
(3) Chart 3: Data from eHome day
(4) Column 1: Data from PBOC
(5) Chart 4: Data from Investing.com
(6) Cordella, Tito, and Ebooks Corporation. Reserve Requirements in the Brave New
Macroprudential World. Washington, D.C: The World Bank, 2014
(7) Yu, Dong, Research on the effect of deposit reserve rate change on stock price and
listed commercial banks in China, Liaoning: Ocean University of China, 2012
(8) P. Sellin, Monetary policy and the stock market: theory and empirical evidence,
Journal of Economic Surveys 15, 2001
(9) Jin, Liling. 存款准备金率的调整对我国股票市场的影响[D]. Sichuan：
Southwestern University of Finance and Economics，2012.
(10) John Knight and Wei Wang, China's Macroeconomic Imbalance: Cause and
Consequences, University of Oxford, 2011