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China needs more than reserve-ratio cuts to boost credit growth, analyst says

After China lowered the amount of cash banks must set aside as reserves for the fourth time this year, the government should also consider lowering another key short-term interest rate to free up more cash for lending, an analyst said.

The People's Bank of China said it will on Oct. 15 lower the required reserve ratio for most banks by 1 percentage point, freeing up at least 750 billion yuan for lending. This will add to the 1.100 trillion yuan of cash released by previous cuts in April and July. The central bank did not say how much liquidity was released by the cut in January.

However, credit growth has picked up only modestly. Outstanding yuan loan expanded by 13.2% year over year in July and August, up from between 12.6% and 12.8% in February through June, according to data released by the People's Bank of China.

Julian Evans-Pritchard, senior China economist with Capital Economics, said China should also lower the 7-day reverse repurchase agreements, or reverse repo, at which the central bank lends to banks during its daily open market operations.

A lower reverse repo rate will likely have a direct and larger impact on pushing interbank lending rates lower, which may help translate the reserve-ratio cuts to stronger lending, Evans-Pritchard added.

He expects a 50-basis point decline in the 7-day reverse repo rate by the end of this year. The central bank's 7-day reverse repo rate has remained at 2.55% since March.

"This will, along with the decline in interbank rates that has already taken place, help drive a recovery in credit growth, which we think may bottom out by the end of the year," said Evans-Pritchard.

The 7-day reverse repo rate is often seen as the de facto policy rate in China, and acts as a floor for market rates.

China hasn't cut the benchmark interest rate since October 2015. Instead, it has been maneuvering banks' reserve ratios and other short-term interest rates to control market liquidity as the country faces two competing policy goals: supporting economic growth and unwinding excess credit.

But as global trade tensions escalate in recent months, additional liquidity is needed to maintain the country's credit and economic growth, particularly for small businesses and exporters which are more vulnerable to potential liquidity squeeze, analysts said.

Li Chao, an analyst with Huatai Securities, expects the Chinese authorities will likely further reduce reserve requirement ratio for banks. Li said slowing growth in deposit is limiting domestic banks' capacity to extend loans, and an even lower reserve requirement ratio will ease banks' funding pressure and support lending.

As of Oct. 5, US$1 was equivalent to 6.87 Chinese yuan.