China may lean on RRR cuts in policy easing if slowdown persists

BEIJING (Reuters) - China's central bank could rely on cutting the amount of cash the banks must hold as reserves to bolster growth but reserve further interest rate cuts as the last-resort policy option, economists familiar with Beijing's policy-making process said.

Fresh policy support may be needed as growth may not bottom out in the second quarter, or the pace of recovery could be sluggish, they said, citing continued weak global demand.

The People's Bank of China cut benchmark rates on June 7 for the first time since the 2008/09 global crisis, following three cuts in banks' reserve requirement ratio (RRR) since November.

The timing surprised investors, who feared it could signal the world's second-largest economy was headed for a hard landing. But while later economic data for May did confirm growth was cooling, it gave no indications of a precipitous decline.

"The central bank could cut RRR further, but it could be very cautious in cutting interest rates, unless the economy continues to slow at a pace faster than expected," said Wang Jun, senior economist at the China Centre for International Economic Exchanges (CCIEE), a Beijing-based think-tank.

"Policymakers have realized that it's impossible to loosen policy aggressively as that could be costly. Property prices are one of the top concerns for them," he told Reuters on Tuesday.

Echoing economists' concerns that China's slowdown could persist into the second half of the year, a growing number of Chinese bankers expect Beijing to loosen policy further in the third quarter, according to the latest central bank survey released on Tuesday.

While Chinese banks' lending picked up in May from April, analysts worry that many of the new loans may be related to the government's fast-tracking of infrastructure projects, as opposed to reflecting a pick-up in broader economic activity.

Beijing has made clear that it will not repeat another massive fiscal stimulus similar to the 4 trillion yuan ($629 billion) spending package launched in late 2008, which bolstered growth but left an unwelcome legacy of strong inflationary pressures and a potential property bubble.

Still, the government has introduced a host of more modest stimulus measures in recent months, such as resuming a "cash for clunklers" scheme to trade in old cars for new ones and offering consumers incentives to buying energy-saving home appliances.

WHEN WILL THE ECONOMY BOTTOM OUT?

China's annual economic growth is almost certain to dip below 8 percent in the second quarter - the sixth straight quarter of slowing expansion - although analysts are divided on whether it will bottom out in the period.

"I don't think growth will hit a bottom in the second quarter. Macro-economic policies should be loosened further as the slowdown could persist in the second half," said He Liping, dean of the finance department at Beijing Normal University.

"On monetary policy, the central bank will focus on quantitative tools. It has been cautious about cutting interest rates, which is more powerful tool that affects firms' borrowing costs and residents' willingness to spend," he told Reuters.

Consumers and investors saw the recent rate cut as a clear signal of further policy easing, state media reported.

While consumers believe prices will rise in the third quarter, they are more willing to spend, according to the PBOC survey, indicating Beijing's more targeted stimulus measures such as incentives to buy air conditioners are starting to work in reviving domestic demand.

Some 15 percent of the 20,000 households polled planned to buy cars in the next three months, the highest since the survey began in 1999.

Nearly 16 percent also said they plan to buy a home in the next three months, fearing that housing prices are set to rise.

That finding could worry Beijing, which has been trying to take speculative steam out of the property market for the last two years and curb inflation.

If the property market is bottoming, it could reduce the risk of a crash that would destabilize the economy and the banking system, but also revive price pressures which will limit policymakers' options to deal with the economic slowdown.

Annual inflation cooled more than expected to 3 percent in May, giving Beijing more room to focus on growth.

2012 GROWTH TARGET STILL ACHIEVABLE

Most analysts believe China is likely still is on track to achieve the official 7.5 percent annual growth target this year, even as some are penciling in more aggressive easing by the central bank.

Peng Wensheng, chief economist at China International Capital Corp (CICC), the country's top investment bank, has cut his outlook to 7.8 percent from 8.1 percent and trimmed his forecast for full-year inflation to 2.8 percent.

CICC expects the central bank to deliver two more interest rate cuts, with the next seen in August, and another two or three RRR cuts this year.

"Economic growth could bottom out soon due to policy support, but the extent of recovery will be small, reflecting constraints from falling potential growth and the process of reducing property sector bubbles," Peng said in a research note.

One influential government adviser said last week that China's annual economic growth could drop below 7 percent in the second quarter, the most pessimistic forecast of any government or private-sector economist.

(Editing by Kim Coghill)

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