In a bid to strengthen the economy amid trade conflicts with the United States and to restore investor confidence, The People’s Bank of China (PBOC) said that it will lower the amount of cash that some banks (which is known as the reserve requirement ratio) need to keep as reserve by 50 basis points (bps).
Currently, the reserve requirement ratio (RRR) for large banks and smaller banks is 16% and 14%, respectively. PBOC noted that the latest reduction in RRR will be enacted on Jul 5. The move is expected to free $108 billion in liquidity to quicken the clip of debt-for-equity swaps, boost lending to smaller firms and strengthen the economy.
Particularly, mid-sized and small banks will see a 200-billion increase in funding from the RRR cut which js targeted at turning around struggling or cash-strapped small businesses. This marks the third cut in the reserve requirement ratio this year. Though the latest move was predictable, the size of the cut ($108 billion) was bigger than expected.
Why the Cut?
Central bank had to take some simulative measure as China’s financial regulatory clampdown had started impeding business activity. Investors should note that the Caixin China General Manufacturing PMI was 51.1 in May 2018, the same as in April but lower than market expectations of 51.3.
Liquidity crunch has long been a problem for Chinese firms, resulting in increased credit defaults and painful operating conditions for small-scale manufacturers. The weighted average borrowing costs from non-financial firms have been on the rise, per Reuters.
Plus, a bull-blown trade war fear with the United States is another concern. With the export sector likely to be hit by a rise in U.S. import tariffs, China had to take the best preventive measure to shore up domestic demand (read: Slowdown in April Retail Sales Put China ETFs in Focus).
Inside EscalatingTrade Tensions
Trade tensions between China and the United States, which have been lingering for more than three months, hit a fever pitch of late. Both the countries will enact a 25% tariff on each other’s $34 billion worth of goods starting Jul 6. The remaining $16 billion worth of goods will be under public review.
The first round of U.S. tariff will apply to 818 imported Chinese goods, including auto, electric cars, aerospace, communications tech, new materials and robotics. In retaliation, China will penalize 545 American goods in the first round (read: Time to Buy Defensive ETFs?).
But the situation may take an uglier turn as the White House plans to slap tariffs on an extra $200 billion worth of Chinese goods, if China keeps retaliating (read: 5 Sector ETFs Most Exposed to Trade Tensions).
How Effective Was the RRR Cut for Chinese Markets?
WisdomTree Chinese Yuan Strategy ETF (CYB - Free Report) lost about 1% on Jun 25, thanks to China’s policy easing. iShares China Large-Cap ETF (FXI - Free Report) slipped about 2.25%, completely overruling the central bank’s accommodative move. iShares MSCI China Small-Cap ETF (ECNS - Free Report) also lost about 1.9% on the day. It seems escalating trade war fears and slowing growth have taken a toll on the Chinese market.
ETFs in Focus
Almost all China ETFs were in the red in the last one-month frame. While Invesco Golden Dragon China ETF (PGJ - Free Report) (down 0.6%) was the least hurt, VanEck Vectors ChinaAMC SME-ChiNext ETF (CNXT - Free Report) faced the most severe blow(down 13.8%).
Needless to say, inverse China ETFs gained out of the situation with Direxion Daily China 3x Bear Shares (YANG - Free Report) rising 22.9% and ProShares UltraShort China 50 (FXP - Free Report) (up 15.1%) gaining considerably.
China ETFs had a nice spell in the past year but it seems the market is due for a correction. Chances of a quick rebound are low unless the trade conditions and economic picture improve.
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