China’s Central Bank Cuts Reserve Requirements, Sparks Stock Market

China’s central bank, the People’s Bank of China (PBOC), announced on October 1 that it will cut the required reserve ratio for banks that met targets on lending to agricultural enterprises and small businesses, effective starting 2018. While such a change was expected, analysts did not believe that it would be announced until next year, according to Reuters.

The PBOC will reduce the required reserve ratio by 0.5 percent for banks whose loans to small and agricultural businesses account for at least 1.5 percent of their total loans, and by 1.5 percent for banks whose loans to qualifying businesses account for 10 percent of their total loans. Analysts project that the 0.5 percent ratio cut will apply to every major bank, as well as 85 percent of small rural banks and 90% percent of small urban banks, according to research by the China International Capital Corporation.

The decision, according to the PBOC, strives to promote inclusive lending and does not reflect a broader change in their “prudent and neutral” monetary policy. A report by Bloomberg noted that the goal of the ratio change is not to affect liquidity, but to increase efficiency and growth.

The targeted cut appears to meet China’s current goal of preventing a slowdown in the real economy while reigning in speculative financial and real estate investments. The cut will also limit corporate debt, which has soared in recent years. Previous efforts to spur lending were not targeted toward small businesses and therefore contributed to speculative investments, especially in real estate.

The move caused a rally in the stock market on October 9, the first day of trading after the announcement, which coincided with the weeklong National Day holiday. The CSI 300, a major Chinese stock index, rose 1.6 percent, and the Shanghai and Shenzhen indices rose 1.3 percent and 1 percent, respectively.

The Hong Kong stock exchange, which resumed trading on October 3, saw even greater gains. The Bank of China, the Agricultural Bank of China, and the Bank of Communications all witnessed gains of between 3 percent and 5 percent, while shares in the China Construction Bank rose by nearly 6 percent. The Industrial and Commercial Bank of China, the world’s largest bank by total value of assets, and the China Merchants Bank saw shares increase by 8 percent. This reflects analysts’ assumptions that the reduced rate will greatly increase the profits of large and medium-sized lenders.

Stock market growth has continued at pace in the week since the announcement. It remains to be seen, however, if the policy will translate into the real economic development the central bank desires.