Interpreting the People's Bank of China's work conference for the second half of the year: Interest rate cuts may be implemented earlier, and a 50 basis point reserve requirement ratio cut can be expected.

The People's Bank of China emphasized at the work conference for the second half of the year on August 1st that it will "maintain reasonable and ample liquidity," "guide commercial banks to adjust the interest rates of existing individual housing loans in an orderly manner in accordance with the law," and "coordinate and promote the resolution of local government debt risks" and other arrangements.

Analysts Xu Dongshi and Zhan Lu from China Galaxy Securities interpreted this conference in a report on August 1st, believing that the central bank emphasized maintaining loose and "reasonably ample" liquidity in order to change market expectations for liquidity and create a favorable monetary and financial environment for stable growth of the real economy.

The analysts pointed out that a downward trend in interest rates can be expected in the second half of the year, as the central bank's focus encompasses both enterprises and residents, thus support for residential housing loan interest rates can be anticipated. The probability of the central bank further lowering policy rates in the second half of this year increases as interest rates continue to decline in an orderly manner. Given the pressure on the renminbi exchange rate, the decline in interest rates may occur in the fourth quarter. However, the central bank's tolerance for the renminbi exchange rate is increasing, and a rate cut in the third quarter is not ruled out. It is necessary to pay attention to changes in the money market interest rates and deposit rates.

Change in Monetary Policy Tone to "Ample," with Parallel Use of Quantity and Structural Tools

The conference pointed out the need to "utilize both quantity and structural monetary policy tools to strongly support technological innovation, green development, and the development of small, medium, and micro enterprises, and strive to enhance new growth drivers."

Regarding this, analysts from China Galaxy Securities believe:

"In terms of quantity, the central bank did not mention that 'the growth rate of money supply and social financing scale should basically match the nominal economic growth rate,' and the continuous decline in the growth rate of social financing may come to an end;

More importantly, there is an increase in structural monetary tools, and the three directions mentioned are technological innovation, green development, and the promotion of small, medium, and micro enterprises.

At present, the usage quotas for structural tools in technological innovation, carbon reduction, and inclusive small and micro enterprises are 20%, 43%, and 50% respectively, and there is still a considerable amount of remaining quotas. The focus is on urging the use of existing quotas. The 200 billion yuan of structured loans for building delivery guarantees by the central bank has been fully utilized, and the quota for building delivery guarantees may be released again in the future."

Continued Decline in Interest Rates, Residential Credit Interest Rates Come into View

The conference also pointed out the need to "continue to deepen the market-oriented reform of interest rates, promote the stability with a slight decline in the comprehensive financing cost of enterprises and residential credit interest rates," as well as "guide commercial banks to adjust the interest rates of existing individual housing loans in an orderly manner in accordance with the law."

Regarding this, analysts from China Galaxy Securities wrote in the report:

"Not only will the comprehensive financing cost of enterprises decrease, but residential credit interest rates should also stabilize with a slight decline. The interest rates of individual existing housing loans in the real estate sector should also be adjusted in an orderly manner.

We believe that a downward trend in interest rates can be expected in the second half of the year, as the central bank's focus encompasses both enterprises and residents, thus support for residential housing loan interest rates can be anticipated. The probability of the central bank further lowering policy rates in the second half of this year increases as interest rates continue to decline in an orderly manner.

Given the pressure on the renminbi exchange rate, the decline in interest rates may occur in the fourth quarter. However, the central bank's tolerance for the renminbi exchange rate is increasing, and a rate cut in the third quarter is not ruled out. It is necessary to pay attention to changes in the money market interest rates and deposit rates.

From a practical perspective, the adjustment of policy interest rates to the LPR period has been relatively slow. At the same time, long-term policy interest rates tend to be lower than the potential GDP level, and the impact of the epidemic has not been fully taken into account in determining the potential GDP.

First of all, the central bank's policy formulation has weak considerations for the impact of the epidemic. From the downward trend of interest rates, since 2020, China's 1-year loan prime rate (LPR) has decreased by 60bps, which is weaker in terms of intensity and speed than in the past. This is consistent with the theoretical basis of the central bank. According to the determination of the central bank's potential growth rate, the downward trend of interest rates should be stable.

Secondly, from a historical perspective, the average policy interest rate is about 250bps lower than the potential growth rate, which means that even if the potential growth rate is 5.5%, the nominal policy interest rate is more likely to decline to around 3.1%."

The focus of real estate policies still lies in demand

This meeting first mentioned "guiding the down payment ratio" and "adjusting the interest rates of existing individual housing loans".

Analysts pointed out that the overall real estate policies aim to meet the demand for both rigid and improved housing, with a focus on improved housing, and continue to implement housing credit policies tailored to different cities. The supply side still focuses on extending the implementation period of the loan support plan for completed buildings, maintaining stable and orderly real estate financing, consistent with the Politburo meeting.

Analysts believe that real estate support in the second half of the year will still focus on the residential side, including the downward adjustment of the down payment ratio, the decrease in loan interest rates, the relaxation of restrictions on home purchases and loans, and the possibility of further lifting of purchase restrictions, all of which will stimulate the demand-side market.

The order of risk prevention has changed, shifting from key institutional risks to local debt risk resolution

The meeting pointed out that the central bank will coordinate and promote the resolution of local debt risks.

Analysts believe that the introduction of central bank policies is in line with the "debt resolution plan" discussed in the Politburo meeting. However, financial support for local government debt risk resolution is just a means of "risk prevention". This also means that in the second half of the year, the risks of local governments facing debt difficulties will be released in an orderly manner. Concerns about local government debt will ease in the second half of the year.

Currently, the balance of local government debt continues to expand, and the pressure of interest payment increases. Interest rate cuts help alleviate the debt pressure. According to data from the Ministry of Finance, as of the end of June 2023, the total balance of local government debt has risen to 37.8 trillion yuan, with interest payments of 593.6 billion yuan in the first half of the year.

Increased attention to foreign exchange policies

Regarding the meeting's statement on foreign exchange policies, analysts from banks and securities firms believe:

"The fluctuations in the RMB exchange rate since the beginning of this year have been closely monitored by the central bank. At the current stage, the RMB exchange rate fluctuates in the range of 7.1 to 7.2 yuan, and it is still affected by the US dollar and the downward trend of domestic interest rates.

In the second half of the year, the central bank may increase its voice on the exchange rate fluctuations and increase the frequency of using foreign exchange market regulation tools. In other words, after raising the macro-prudential adjustment coefficient for cross-border financing on July 20, measures such as foreign exchange risk reserves, foreign exchange deposit reserve ratio, daily fixing rate, and adjustment of foreign exchange transaction costs will be used." The use of foreign exchange adjustment tools will gradually proceed as the renminbi exchange rate declines. We believe that the USD/CNY rate is still worth paying attention to at 7.3, and the central bank will increase its regulatory efforts at this level.

This also indicates that the central bank has increased its tolerance for fluctuations in the renminbi. In the past, the adjustment level was around 7.2, which means that the tolerance bottom line for USD/CNY may be pushed to 7.4.

Central Bank Shifts to a Positive Stance in the Second Half of the Year

Analysts in the report stated that overall, the central bank's monetary policy easing can be foreseen as it follows the central government's judgment on changes in the economic situation. There can be a more optimistic outlook for the increase in social financing and credit growth in the second half of the year. The implementation of structural financial instruments in key areas will also continue. The market has strong expectations for the anticipated reserve requirement ratio (RRR) cuts and interest rate reductions in the second half of the year.

At the same time, analysts at Galaxy Securities have even further policy expectations for the second half of the year compared to the market expectations:

(1) The resolution of local government debt and the stable operation of the real estate market may require the central bank to expedite the introduction of structural facilitation tools. In addition to the possible increase in the "baojiaolou" special fund (200 billion RMB), more financial instruments to stabilize market risks, especially policy-based financial instruments, may be implemented on a larger scale.

(2) The implementation of RRR cuts may exceed expectations. In other words, in order to complement the use of policy-based financial instruments, it can be expected that there will be two RRR cuts totaling 50 basis points, releasing more than 1 trillion RMB.

(3) The interest rate cuts, which were generally believed to occur in the fourth quarter, may be brought forward, especially given the central bank's increased tolerance for exchange rate fluctuations, close attention to the foreign exchange market, and expectation guidance. There is also a certain probability of interest rate cuts in the third quarter, ahead of the market.