The People’s Bank of China (PBOC) is encouraging Chinese banks to lend more to businesses and consumers by cutting the proportion of deposits that they have to hold as reserves by 0.5 percentage points to an average of 8.4% from December 15.

It follows a similar cut in July and is an interesting counterpoint to western central banks such as the Bank of England and Federal Reserve. They are talking about tightening monetary conditions to dampen inflation by raising interest rates and reducing quantitative easing, which effectively creates more money to stimulate lending.

So why are the Chinese loosening and what effect will it have?

China’s growth headache

The official reasoning is to ease credit conditions in the face of a slowing property sector and a disappointing annual GDP growth rate of 4.9% in the third quarter, down from 7.9% in the second quarter.

The cut in the bank reserves minimum, which is known as the required reserve ratio or RRR, is expected to release 1.2 trillion yuan (US$189 billion) of extra money into the economy.

This aims to bolster demand within China so that the modest government growth target of 6% in 2021 will be met. It could achieve that short-term goal by stimulating demand if credit expands and gets to the right places. And, unlike the west, inflation is less of a problem in China because the money supply has been growing slowly.

Despite the hype about China bouncing back from its lockdown experience, the pandemic has not helped its economic situation. Like the rest of the world, it has encountered major supply disruptions. Some have been domestically driven but most are global, with shortages of electronic chips, coal, steel and shipping capacity causing power shortages and shutdowns.

But these are short-term problems that may dissipate as the pandemic eases. Unfortunately, there are also long-term issues that tinkering with the RRR will not solve.

Pillars wobbling

Growth in China was in fact declining well before the pandemic struck: from a peak of 15% in the second quarter of 2007 to 6% in the first three months of 2019.

The nation’s growth strategy rests on four pillars. Three are frequently talked about – infrastructure, exports and consumers – while the fourth is only whispered in official circles – and that is the property sector.

The property sector supports 25%-29% of China’s GDP and it is struggling. With major players such as Evergrande overloaded with debts and struggling to stay viable, prices for new homes are falling and construction has greatly slowed.