What could be the most effective means to ease liquidity in China?

BBVA suggests PBoC should cut rates asymmetrically to help stimulate the demand for loans but warns that bank profitability may have to suffer.

ABF: Following reports of still weak demand for loans in China, what could be the most effective means to ease liquidity in the country?

BBVA: Alicia Garcia-Herrero, Chief Economist of Emerging Markets
As regards China’s credit slowdown, not all is a demand problem as many have argued but also a supply one in as far as banks are worried about the future quality of their assets. This is particularly the case of loans extended to LGFVs and developers but it could be more generalized as the economy slows down. In as far as it is a demand problem, a cut in reserve requirements might not be the best instrument while an interest rate could prove more effective (directly reducing the cost of borrowing and thus increasing the demand).

As for the supply issue, it would be important for the Chinese government to clarify whether – or better to what extent – local governments (or the central government eventually) will be ready to stand behind the loans extended to LGFVs. One more important point related to a possible cut in interest rates is that the Chinese authorities are still reluctant to cut rates due to lingering concerns over the inflation.

Now China's (one year) deposit interest rate is marginally higher than inflation (3.5% versus 3.45) so a cut in rates would bring real interest rates even further down. One way to go about would be for the PBoC to cut rates asymmetrically (i.e., only cut lending rate while keep the deposit as it is). This should help stimulate the demand for loans although it would negatively affect bank profitability. It might not have been so wise from the side of Chinese banks to have posted such high profits after all!  

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