Source: Zhitong Finance

China Merchants Securities released a research report saying that on March 17, according to the central bank's official website, the People's Bank of China decided to reduce the deposit reserve ratio of financial institutions by 0.25 percentage points on March 27 (excluding financial institutions that have implemented a 5% deposit reserve ratio). After this reduction, the weighted average deposit reserve ratio of financial institutions was about 7.6%. As far as asset prices are concerned, the downgrade does not indicate another relaxation of monetary policy, so its positive significance for the bond market (especially interest rates on long-term bonds) has clearly weakened.Based on the present, since tight liquidity is one of the main factors leading to the rise in post-holiday short-term bond yields, this downgrade is beneficial to easing the pressure on short-term debt.On the equity market side, the downgrade is theoretically conducive to promoting credit investment and ensuring abundant liquidity in a broad sense, but it is important to be aware that the current growth rate of medium- to long-term corporate loans is close to an all-time high, and risks may arise if it turns a corner.

Incidents:

On March 17, the central bank unexpectedly downgraded. According to the central bank's official website, the People's Bank of China decided to reduce the deposit reserve ratio of financial institutions by 0.25 percentage points on March 27 (excluding financial institutions that have implemented a 5% reserve ratio). After this reduction, the weighted average deposit reserve ratio of financial institutions was about 7.6%.

▍ The main views of China Merchants Securities are as follows:

The three anomalies of this downgrade

Compared with previous downgrade operations, there are three anomalies in this downgrade:

1) The State Council has yet to release a signal; the central bank directly announced the downgrade decision.Historically, whenever interest rate cuts are introduced, the State Council usually first sends a signal at an executive meeting, and the central bank immediately studies and implements them. For example, on November 22 of last year, the National Standing Committee proposed “guide banks to make reasonable concessions on inclusive microfinance stock loans... use monetary policy tools such as downgrades in a timely and appropriate manner to maintain reasonable and abundant liquidity.” Three days later (November 25), the central bank announced a 0.25 percentage point reduction on December 5.

Unlike in the past, the State Council did not release a clear signal prior to this downgrade. Although the central bank proposed “using the downgrade method to provide long-term liquidity and support the real economy, comprehensive consideration is still a relatively effective method” at the “Authorities Speak for the Beginning” series of press conferences organized by the State Information Office at the beginning of the month, this only shows that the downgrade is necessary, and it is difficult to see from it the urgency of the current downgrade.

2) The central bank's downgrade announcement did not specify the specific purpose.Historically, while downgrading, central banks will clarify specific purposes by answering questions from reporters. For example, at the time of the last downgrade (November 25), the central bank indicated that the purpose of the downgrade was to 1) maintain reasonable and abundant liquidity, 2) optimize the financial structure of financial institutions, and 3) the capital costs saved by the downgrade could be used to promote the reduction of comprehensive financing costs for the real economy.

Unlike in the past, judging from the information currently published on the central bank's website, it did not communicate with the market about the purpose of this downgrade in accordance with established practices, such as answering reporters' questions, etc., nor did it disclose important information such as the scale of long-term capital released by the downgrade and the cost of capital saved. The amount of information and transparency of this downgrade operation is clearly not as good as in the past.

3) MLF's excessive sequel was released at the same time as the downgrade, which is rare in history.In the central bank's liquidity management toolbox, MLF, structural policy tools (such as PSL), and downgrades can all play a role in complementing banks' medium- to long-term liquidity and have similar effects, so it is rare for multiple instruments to be used at the same time.

This week, the central bank used MLF tools to invest 481 billion yuan in medium- to long-term capital, and achieved a net investment of about 281 billion yuan after falling short, the highest in a single month in the first quarter. The amount invested exceeded market expectations. In the second quarter, the MLF maturity scale was at a low level throughout the year. Faced with pressure to return liquidity at special times such as crossing months and tax payments, the central bank could respond flexibly through MLF overinvestment, etc., and the need to use downgrades did not seem obvious.

Based on the above three points, this downgrade has exceeded previous expectations, as well as the general expectations of the market. The hidden information behind the abnormal operation is worth following and observing in the market.

Possible considerations for this downgrade

Since the central bank did not immediately disclose the purpose of this downgrade, based on historical experience, the following inference was drawn:

Inference 1. The MLF balance has broken through the “threshold”, or the downgrade has been triggered to replace the MLF motivation.Historically, central banks have replaced MLF through downgrades many times, thereby reducing banks' debt-side costs and “protecting” medium- to long-term loan investments. For example, in 2018/10, the central bank downgraded the overall level by 1 percentage point. In the “Monetary Policy Implementation Report” for the third quarter released later, the central bank stated that “part of the funds released by the downgrade will be used to repay the approximately 450 billion yuan MLF due on the same day, further increasing the stability of capital in the banking system and optimizing the liquidity structure of commercial banks and financial markets.”

Combining historical experience, the MLF balance exceeded 5 trillion yuan, which is the threshold value for the central bank to carry out downgrades and replacements. As of February, the MLF balance was 4828 billion yuan, plus the net investment of 281 billion yuan in March. The current balance has exceeded the 5 trillion yuan threshold. According to empirical speculation, the central bank is currently motivated to use downgrading tools to carry out MLF swaps, guarantee the continuous investment of medium- to long-term loans, and achieve the primary goal of high-quality development.

Inference 2. Deposits are increasing unseasonally, and the downgrade can hedge the pressure on banks to approve payments.In the context of the real sector increasing precautionary savings, in the first two months of this year, the real sector added 8.7 trillion dollars in deposits, far exceeding the same period in history. Among them, February showed the most outstanding performance. An overseasonal increase in real sector deposits will cause banks to pay a marked increase in statutory reserve funds, thereby putting pressure on the liquidity of the interbank market.

March is usually the “big month” of deposit growth. During the three-year pandemic, the average size of new deposits added in that month increased nearly three times compared to before the pandemic. If we calculate the 7.8% statutory reserve before this downgrade, this month's reserves will need to be overpaid by about 400 billion yuan, a significant increase from the previous two months. This will put obvious pressure on cross-season liquidity. By downgrading 0.25 percentage points and releasing about 500 billion dollars of long-term liquidity, the central bank can hedge against the impact of the increase in deposits and ensure reasonable and abundant liquidity.

The possible impact of this downgrade

As far as liquidity is concerned, this month is the “big month” of fiscal spending, and the liquidity gap is not obvious. In the first half of the month, interest rates on 1-year deposits were slightly higher than MLF interest rates and operated smoothly. After the downgrade, interest rates on deposit notes fell rapidly, and the interest rate difference between the two widened again. Judging from the pace, since this month's fiscal expenditure is mainly concentrated at the end of the month, which is close to the date of implementation of this downgrade (27th), it is expected that under the combined effect of the two, market liquidity will be stable and secure during the cross-season period.

As far as asset prices are concerned, the downgrade does not indicate another relaxation of monetary policy, so its positive significance for the bond market (especially interest rates on long-term bonds) has clearly weakened. Based on the present, since tight liquidity is one of the main factors leading to the rise in post-holiday short-term bond yields, this downgrade is beneficial to easing the pressure on short-term debt.

On the equity market side, the downgrade is theoretically conducive to promoting credit investment and ensuring abundant liquidity in a broad sense, but it is important to be aware that the current growth rate of medium- to long-term corporate loans is close to an all-time high, and risks may arise if it turns a corner.

Risk warning:

The economy is stalling and declining, and the risk of policy misjudgment is rising.