In response to economic data published last week which stated that the Chinese economy grew at 7 percent for the first quarter of 2015, the lowest since 2009, the Chinese central bank has reduced the required reserve ratio by 1 percent. This should free up around 1.2 trillion yuan (194 billion dollars) to be loaned in the Chinese economy. This is the second time that China has done this, the last time being in February of 2014. This act of stimulus highlights the slow down occurring within the world’s second largest economy. In the U.S. growth of 7 percent would be unprecedented, but in the growth-centric Chinese economy they need large GDP growth to continue developing for the more than 1 billion Chinese, including millions below poverty. Impressive growth legitimizes its communist rule and keeps Chinese content with their domestic situation.
China’s change in the reserve ratio should have the desired effect so long as banks see a favorable lending climate and are willing to lend to the limit of the required reserves. If however the slowing of growth in China continues then banks may be more apprehensive to loan and may keep more reserves than the required ratio, at which point the change in reserve ratio is no longer an effective stimulus. From then on active monetary and fiscal policy may be needed to stimulate growth. While its not possible to predict the outlook of the Chinese economy, it is certain that at some point in the near future 7 percent+ growth will not be feasible and their economy and policies will need to shift.