What Policy Space Remains for China's Future Monetary Policy?
Lian Ping suggests China should further reduce policy interest rates, while calling for additional local special bond quotas to inject capital into local small and medium-sized banks
In early May, the Chinese Central Bank, PBoC, reduced the 7-day reverse repo operation rate in open market operations from 1.5% to 1.4%. It also reduced the reserve requirement ratio for financial institutions by 0.5 percentage points. Facing economic uncertainty brought by the tariff negotiations, how much policy space remains for future monetary policy? I’ve recently found Dr.Lian Ping’s op-ed talking about the issue, and I think it’s worth sharing.
Lian Ping is the Director and Chief Economist of Guangkai Chief Industry Research Institute, and he’s also the Chair of the China Chief Economist Forum. In his piece, he argues that the quantitative tools like the 0.5 percentage point reserve requirement ratio (RRR) cut will inject 1 trillion yuan of long-term liquidity, while price-based policies show moderate adjustments with a 0.1 percentage point policy rate cut and 0.25 percentage point housing fund loan rate reduction, leaving room for future moves. The RRR cut is timely given external pressures from US tariffs that could reduce China's exports by 8-10% in 2025 and potentially lower GDP growth by 1 percentage point, while domestic demand recovery requires adequate liquidity support.
Looking ahead, China has 2-2.5 percentage points of RRR cutting space, with potential for additional 0.25-0.5 percentage point cuts in Q3. He suggests further rate cuts of 0.2-0.3 percentage points, establishing a 500 billion yuan trade stabilization re-lending facility, resuming government bond open market operations, and fiscal measures including 1 trillion yuan in policy financial instruments and 200-300 billion yuan in special local bonds for small bank recapitalization.
Below is the full article, you can also read the Chinese version: https://www.yicai.com/news/102604606.html
Ten Major Policies Effectively Balance Various Needs
The ten major policies encompass various types, including quantitative policy tools, price-based policy tools, and structural monetary policy instruments. They are both systematic and comprehensive while being highly targeted, helping to maximize the effectiveness of moderately accommodative monetary policy.
Among these, quantitative policy tools represented by the reserve requirement ratio showed significant strength. This includes reducing the reserve requirement ratio by 0.5 percentage points, which is expected to provide 1 trillion yuan of long-term liquidity to the market, helping to better support the real economy and stabilize expectations. Meanwhile, the temporary reduction of reserve requirement ratios for auto finance companies and financial leasing companies from the current 5% to 0% aims to provide stronger financial support for "dual emphasis, dual new"(国家重大战略实施和重点领域安全能力建设, 新一轮大规模设备更新和消费品以旧换新Implementation of major national strategies and security capacity building in key areas, new round of large-scale equipment upgrades and trade-in programs for consumer goods) consumption and investment in automobiles and equipment.
Price-based policies showed moderate strength, leaving some room for maneuver. The 0.1 percentage point cut in policy rates, reducing the 7-day reverse repo operation rate from the current 1.5% to 1.4%, and the 0.25 percentage point reduction in personal housing provident fund loan rates were relatively moderate. On one hand, the effects of previous policy cuts are still being absorbed; on the other hand, once the Federal Reserve clearly restarts its rate-cutting cycle, policy space will open up and relevant rates can be further adjusted as circumstances permit.
Structural policy tools cover a wide range with considerable comprehensive effects. Among the ten major policies, six are related to structural monetary policy tools, including: comprehensively reducing structural monetary policy tool rates by 0.25 percentage points, adding 300 billion yuan in re-lending quotas for technological innovation and technical transformation, establishing 500 billion yuan in "service consumption and elderly care re-lending," increasing 300 billion yuan in re-lending quotas supporting agriculture and small businesses, optimizing two monetary policy tools supporting capital markets, and creating technological innovation bond risk-sharing instruments. Some of these six policies involve readjustments of existing rates and quotas, while others are entirely new establishments. Considering that these six policies cover numerous difficulties and pain points in China's current economy and finance, their combined effect will be quite substantial, addressing both immediate needs and long-term considerations, contributing to China's high-quality economic development.
Current RRR Cut is Very Timely
From the perspective of external shocks, the US began imposing high tariffs on China in April, which will significantly impact China's foreign trade and increase financial market volatility, necessitating timely RRR cuts to release more liquidity to mitigate shocks and stabilize market expectations. Currently, the US comprehensive cumulative tariff rate on China has exceeded 100% (The op-ed was published on May 8, before the Vienna), with potential for more uncertainties ahead. This will inevitably have major impacts on China's exports, consumption, investment, and even GDP. Preliminary estimates suggest that for every 10% increase in US tariffs on China, Chinese exports may decline by 2%-2.5%. Without tariff relief, China's exports could fall by 8%-10% in 2025, with export growth potentially declining by around 15% in 2026. As exports face obstacles, consumption and investment will also experience chain effects. Without intervention, in extreme scenarios, China's GDP growth rate could potentially drop by about 1 percentage point in 2025. Meanwhile, stock markets have also experienced significant volatility. At this juncture, timely RRR cuts are necessary. Beyond supporting government bond issuance, it's needed to support commercial banks in increasing credit lending, especially to export-related, agricultural, and "bottleneck" industries. It's also needed to support policy banks, commercial banks, securities firms, insurance companies, funds, and other leading financial institutions, along with large central SOE groups and numerous listed companies, in increasing holdings of financial assets to stabilize stock markets and market confidence.
From both macro and micro perspectives, RRR cuts have multiple effects, including promoting domestic demand recovery and accelerating structural adjustments. From 2020 to 2024, the central bank reduced RRR by 1.5, 1.0, 0.5, 0.5, and 1.0 percentage points, respectively. The moderately accommodative monetary policy in 2025 will further strengthen macroeconomic regulation, maintain ample market liquidity, and the "moderately accommodative" tone should also be reflected in RRR cuts.
From a macro perspective, RRR cuts are needed to release more liquidity to meet funding demands for current investment and consumption expansion and confidence restoration. In recent years, credit and social financing have maintained rapid growth with annual increments showing an upward trend. New credit in 2025 is expected to exceed 21 trillion yuan, social financing increments are expected to exceed 36 trillion yuan, and M2 growth is expected to maintain around 8%. Given this rapid growth in liquidity demand, timely RRR cuts are necessary.
From a micro perspective, financial institutions with ample funds for resource allocation help smooth monetary policy transmission channels, enhance money creation functions, and generate greater money multiplier effects. This helps accelerate credit deployment to key areas including major national construction projects, inclusive finance, small and micro private enterprises, real estate, and consumer markets, strengthens funding capacity for stock and bond markets, supports fiscal efforts and large-scale government bond issuance, and alleviates liquidity pressures for some private enterprises, real estate companies, small and medium financial institutions, and local governments, working harder to mitigate systemic financial risks.
Further RRR Reduction Space Remains This Year
RRR changes are closely related to domestic economic development needs and serve macroeconomic regulation policy objectives. As China's financial market scale gradually expands, monetary policy aggregate regulation transmission chains become more complex, making RRR adjustment of market aggregates more challenging. China's short-term monetary policy adjustment tools are relatively abundant with more flexible operations, and money markets are gradually maturing. From over 40 years of monetary policy operations, the central bank has accumulated flexible RRR adjustment experience. Theoretically, RRR could seemingly go lower or even approach 0%. For prudential considerations, maintaining a certain "buffer zone," RRR could be maintained in the 3%-5% range. Before this cut, China's commercial banks' weighted average RRR was 6.6%, reduced to 6.2% after this adjustment. Future reduction space remains. Based on China's current economic scale, growth speed, financial market development level, liquidity conditions, and banking system risk prevention and resolution capabilities, China's RRR could be reduced to levels between most developed countries' 1% and most major emerging economies' 5%, and even below 5% should be acceptable. For the foreseeable future, China has at least 2-2.5 percentage points of RRR reduction space.
In 2025, considering market demand, especially supporting fiscal policy, including this RRR cut, total annual RRR reduction of 0.75-1.0 percentage points would be appropriate to release more medium and long-term funds to meet market demand. Therefore, Q3 likely has 0.25-0.5 percentage points of RRR reduction space.
Property Market Financial Policies Help Stabilize Real Estate Markets
The central bank announced a 25 basis point reduction in personal housing provident fund loan rates, reducing first-home rates for terms over 5 years from 2.85% to 2.6%. Combined with the 0.1 percentage point policy rate cut, total rate reductions of 35 basis points will directly lower residents' home purchase costs. Calculations show that for combination loans with 1 million yuan each in commercial mortgage and provident fund loans over 30 years with equal principal and interest payments, this rate reduction will cumulatively reduce monthly payments by 67,600 yuan over 30 years.
As of end-April 2025, commercial housing sales area in 30 major cities nationwide declined 1.7% year-on-year, with the decline significantly narrowing from end-2024. In Q1 this year, real estate loan balances increased by over 750 billion yuan, with new personal housing loans showing the largest single-quarter increase since 2022, indicating that the series of policies introduced at end-Q3 last year played a notably positive role in promoting real estate market stabilization, with commercial housing inventory levels gradually declining from high levels.
The financial regulatory authority noted that real estate "white list" loan approvals have increased to 6.7 trillion yuan, up about 1.7 trillion yuan from the beginning of the year, showing that local financial institutions are working from the housing finance supply side, supporting reasonable extensions of real estate companies' existing credit business, meeting real estate company financing needs to some extent, and mitigating real estate company liquidity risks.
In the next phase, commercial banks nationwide are expected to quickly follow central bank policies, gradually reducing personal housing loan rates, further supporting the release of rigid and improving housing demand from the household sector. The central bank will continue extending and implementing real estate "Financial 16 Measures" support policies, expanding financial support for affordable housing construction, thereby promoting and accelerating domestic commercial housing market operation toward supply-demand balance, with the market's long-anticipated stabilization goal expected to be achieved.
What Are the Policy Focus Points for the Second Half?
In monetary policy:
Suggest further reducing policy rates by 0.2-0.3 percentage points. Q1 US economy showed negative growth with increased recession risks. The Federal Reserve is expected to restart rate cuts as early as June, with domestic-foreign interest rate spreads expected to narrow. Against this backdrop, accommodative monetary policy should operate proactively, reducing 7-day reverse repo rates by 0.2-0.3 percentage points, significantly lowering commercial bank funding costs, alleviating operational pressures, effectively pushing down LPR, reducing loan rates and bond issuance costs, stimulating investment and consumption growth.
Suggest establishing 500 billion yuan in trade stabilization special re-lending. Under the impact of US tariff abuse on Chinese manufacturing, related Chinese industries will show clear differentiation. Traditional labor-intensive industries like textiles and apparel, furniture, consumer electronics, toys, and plastic products, due to lower added value, are more easily replaceable or face dual pressures from direct tariff impacts and supply chain restructuring due to heavy dependence on US markets. Suggest establishing 500 billion yuan in trade stabilization special re-lending with re-lending rates as low as 1.0% and loan rates not exceeding 1.5%, focusing on supporting related foreign trade enterprises and their key upstream and downstream companies, coordinating with fiscal policy to stabilize foreign trade.
Suggest restarting government bond open market operations, directly injecting over 500-1,000 billion yuan of liquidity into financial markets. Release large-scale liquidity through aggregate tools like RRR cuts and open market operations, reducing financial institution funding costs and acquisition difficulties, coordinating with large-scale government bond issuance. This will also push down social financing costs, support household and enterprise credit recovery and growth, promoting investment and consumption. Additionally, this releases strong policy regulation signals, enhancing market confidence and stabilizing stock and property markets.
Additionally, in fiscal and quasi-fiscal aspects:
Suggest adding 1 trillion yuan in policy and development financial instruments to effectively drive infrastructure investment expansion. Policy and development financial instruments supplement major infrastructure project capital through equity or bridge funding for special bond project capital, enabling investment expansion without increasing government leverage ratios or deficits. According to regulations, policy, and development financial instrument funding comprises no more than 50% of total project capital, equivalent to about 10% of the entire project funding, meaning it can leverage about 9 times in bank credit and social funding. Currently, China's economy continues to recover and maintain development momentum, but is constrained by negative internal and external factors, it is at the most challenging point of economic stabilization. Policy and development financial instruments help better realize the effective investment's comprehensive effects of "filling gaps, adjusting structure, stabilizing employment, driving consumption," further consolidating the foundation of economic recovery and development. Suggest successively adding at least 1 trillion yuan in policy and development financial instruments, with the China Development Bank and Agricultural Development Bank issuing financial bonds in the second half to raise 1 trillion yuan for fund establishment, while central finance can provide appropriate interest subsidies based on actual equity investment amounts.
Suggest adding 200-300 billion yuan in local special bond quotas specifically supporting local government capital injections into small and medium banks. China's financial system is dominated by bank indirect financing, with commercial banks playing irreplaceable key roles in supporting major national infrastructure construction, real economy development, government bond issuance assistance, and inclusive finance implementation. In recent years, due to accelerating net interest margin compression and declining profit growth, commercial banks' endogenous capital supplementation channels have continuously shrunk, limiting their ability to better provide financing for the real economy. To alleviate this contradiction, beyond timely targeted RRR cuts for large and medium commercial banks to release more available credit funds while continuing to support city commercial banks, rural commercial banks, and other local legal person banks in expanding perpetual bond and tier-2 capital bond issuance scales, suggest that central finance could add 200-300 billion yuan in local special bond quotas specifically supporting local government capital injections into small and medium banks, helping them accelerate "recovery," enhancing their capacity to serve the real economy and prevent and control risks, especially strengthening support for small and micro enterprise financing capabilities.