China`s central bank unexpectedly said on Tuesday it will reduce the cash banks hold as reserves, a move that frees up lending for small firms but falls short of broad monetary easing, with the authority attaching requirements on how funds must be used.

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Reserve requirement ratios (RRRs) -- currently 17 percent for large institutions and 15 percent for smaller banks -- will be cut by 100 basis points (bps), the People`s Bank of China (PBOC) said.

The change will be made on April 25 and will apply to most banks with the exception of policy lenders such as China Development Bank.

But the banks must use most of the freed-up liquidity to pay back relatively costly loans obtained via the central bank`s medium-term lending facility (MLF). Based on first-quarter data, the PBOC said the MLF loans due to be repaid on April 25 will be about 900 billion yuan ($143 billion).

Whatever funds the banks have left after repaying their MLF loans must be used to provide loans to small businesses. The PBOC said there will be 400 billion yuan in excess funds after the MLF loan repayments.

The authorities have kept monetary policy in a neutral gear as they continue to clamp down on high corporate debt levels and risky lending practices that might harm China`s financial system. The last time benchmark interest rates were cut was in October 2015.

"Today`s required reserve ratio cut doesn`t constitute broad monetary easing. But it does signal that -- despite the recent strength of the official data -- policymakers are starting to balance concerns about economic conditions alongside their longstanding desire to contain credit risks," said Mark Williams, Chief Asia Economist at Capital Economics.

The PBOC`s unexpected decision to cut RRRs came after official data earlier on Tuesday showed China`s economy grew a faster-than-expected 6.8 percent in the first quarter.

Analysts still expect the economy to lose momentum in coming quarters, however, as authorities force local governments to scale back infrastructure projects to contain their debt and property sales cool due to strict controls on purchases to fight speculation.

A full-blown trade war with the United States could also impact billions of dollars in trade.

Net exports overall were already a drag on growth in the first quarter after giving an added boost to the economy last year, highlighting the need for sustained strength in domestic demand if significant new U.S. tariffs are imposed.

"Rising Sino-U.S. trade tensions are clouding the outlook for China`s exports," said Xu Gao, a Beijing-based economist at Everbright Securities.

"China needs domestic demand to hold up in the face of increasing uncertainties in external demand, so it needs the micro-management of monetary policies to make sure the real economy is stable."

The PBOC`s last RRR adjustment was on Jan. 25, when most banks saw at least a 50 bps cut to their RRRs as long as the lenders granted more loans to smaller firms and rural communities.

That adjustment was flagged months in advance in late September.

In a Reuters poll this month, the PBOC was forecast to cut RRRs for all banks by only 50 bps in the fourth quarter of 2018. Analysts had expected two additional 25 bps cuts to follow to then to bring the rate down to 16 percent.POLICY STANCE UNCHANGED

Despite the RRR cut, the PBOC said it would maintain a prudent and neutral monetary policy.

"On the surface, the RRR cut looks neutral because most of it is used to pay back MLFs, but it also shows the PBOC is adjusting its monetary policy to a loosening bias," said Everbright`s Xu.

The PBOC said it required financial institutions to mainly use newly released funds from the RRR cut to provide loans to small and micro companies, and that this would be included as a requirement in its quarterly Macro-Prudential Assessment (MPA) for banks.

Banks included in the cut include large commercial banks, joint-stock commercial banks, city commercial banks, non-county-level rural commercial banks and foreign banks.

The PBOC said the move was also to lower funding costs for lenders.

The interest rate that the PBOC pays banks for depositing their reserves at the central bank is 1.62 percent, but the interest rate the lenders pay for MLF loans from the PBOC is 3.3 percent.

"I think it shows a clear trend of policy relaxation because the interest rate of this year`s MLF is 3.3 percent, but the banks are only receiving 1.62 percent for their reserves at the central bank," said Zhou Hao, senior emerging markets economist at Commerzbank.

"This has greatly reduced the debt costs of banks."

Still, the PBOC said it needed to maintain relatively high RRRs for banks to fend off financial risks.

Yang Yewei, analyst at Southwest Securities, said that while it was the first time the PBOC was cutting RRRs to get banks to pay back MLF loans, it may not be the last.

"Since increasing funding for small firms has been included in the MPA assessment, and considering that the MPA assessment is quarterly, we suspect such measures may be implemented quarterly," Yang said.

"Similar swaps may be done more than one time this year, and approximately a total of 4.9 trillion yuan of MLFs could be gradually replaced. Liquidity conditions will continue to improve."($1 = 6.2804 Chinese yuan renminbi)

(This article has not been edited by Zeebiz editorial team and is auto-generated from an agency feed.)