Morgan Stanley_China Economics A Seemingly Aggressive Move-RRR Hiked by 100bps

What’s New: PBOC announced on Saturday,
December 8 that the ratio for required reserves (RRR)
will be raised by 100 bps to 14.5% effective December
25. This is the tenth RRR hike in 2007 and the first
100-bps hike since 2004.
Conclusion: This 100-bps RRR hike is the first
monetary policy move after the authorities stated that
monetary policy will turn ‘tight’. In this context, the move
carries an important signaling effect. However, we
caution against overreaction, as we believe that the
near-term market impact of this seemingly aggressive
policy move will be rather limited. This move appears
largely aimed at offsetting the liquidity-creation impact of
two year-end factors: the sharp decline in government
deposits at PBOC and sizable FX reserve accumulation.
Implications: Despite ten consecutive RRR hikes in
2007, inter-bank interest rates have moved up only very
gradually for most of the year, suggesting the underlying
liquidity situation has not tightened meaningfully. Going
forward, as the authorities try to pursue a ‘tight’
monetary policy, we believe that quantity-based
measures such as RRR hikes and administrative
controls over bank lending will feature more prominently
than price-based measures, such as interest rate hikes
and exchange rate appreciation in the authorities’
monetary policy management in 2008. In essence, this
policy orientation should result in the banking system
sharing the bulk of macroeconomic adjustment costs
with the central bank.
Risks: Notwithstanding the authorities’ recent
high-profile statement that they aim to pursue a tight
monetary policy in 2008, we believe that the risk of
‘over-tightening’ is quite low and an imported
soft-landing is the most likely scenario in the event of a
global synchronized downturn.