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Yesterday the People’s Bank of China (PBoC) announced that it would cut the reserve requirement ratio (RRR) of Chinese banks by 0.25%.

That would’ve been fine for market players who were expecting such action, if not for the accompanying statement that the central bank is also cutting its one-year interest rate by 0.31% AND is offering an additional 5 billion CNY worth of reverse repo agreements. Talk about laying down the cards!

For newbies out there, a reverse repo agreement is simply an arrangement to buy a security and sell it back at a specific price and date. In the PBoC’s case, it bought government bonds to primary dealers who agreed to buy it back in a week or two.

The aim of the move is to provide short-term liquidity in the markets.

What caught investors’ attention is the PBoC’s urgency in stimulating its economy. The central bank has previously used RRR and interest rate cuts alternately, but yesterday marked the second consecutive interest rate cut for the PBoC.

The central bank also has no worries about stepping up its reverse repo efforts. Along with the 5 billion CNY offered yesterday, the PBoC has injected 143 billion CNY worth of liquidity (the largest amount in six months) into its banking system last Tuesday and around 197 billion CNY last week.

Is the world’s second-largest economy in deeper trouble than most of us think?

A handful of market junkies believe so. After all, didn’t we just see China’s manufacturing PMI clock at its slowest pace since November? Government data showed that growth in the manufacturing sector slowed in June with the index coming in at 50.2 following the 50.4 reading for May. Not only that, but Q1 2012 GDP also printed at its weakest pace in three years at 8.1%. Yikes!

And then there’s the banking system’s need for liquidity. In the past, strong trade surplus and capital inflows pushed the PBoC to print CNY and sell dollars. The move created excess liquidity, which then prompted the PBoC to hike interest rates and RRRs.

But as China’s trade surplus shrinks and capital inflows weaken, liquidity in the economy is drying up. And it looks like it will continue to dry up unless the central bank steps up and implement more easing.

Of course, it doesn’t help that banks are hoarding liquidity themselves for their midyear RRR obligations. China’s banks are expected to make payments on July 5, 15, and 25 in order to meet their RRRs. Word on the hood is that the expected payments are larger this year, as there was a surge in customer deposits at the end of June.

But as the PBoC has demonstrated yesterday, it isn’t just sitting in a corner playing Mahjong while economic growth loses momentum and liquidity in the banking sector dries up.

Along with the central bank’s actions yesterday, it has already cut the reserve requirement ratio for banks three times since November in an effort to get liquidity flowing. Each time, the central bank has reduced it by 50 basis points.

In addition, the PBoC has also lowered its benchmark interest rates by 0.25% to 3.25% in June, the first time since 2008.

Next week we’ll see just how much we should worry about the Chinese economy when the inflation, trade balance, and economic growth figures are released. If the reports print better than their estimates, then we might see the PBoC step back on its liquidity easing efforts. Or not.

Do you think that the PBoC will step back in its efforts next month and let its new policies take effect, or will it continue to stimulate the economy?