China's upcoming reduction in the reserve requirement ratio to zero for certain financial institutions has potentially unlocked substantial scope for further monetary easing, with another cut to the RRR likely in the second half of the year, analysts said.

Effective on Thursday, the RRR — which determines the proportion of deposits financial institutions must hold as reserves — for auto financing and financial leasing companies will be cut to zero from 5 percent.

The unexpected cut, analysts said, may have sent a significant signal that the so-called 5 percent lower threshold for China's RRR — as previously perceived by the market — does not actually exist, releasing up to 6 percentage points of potential easing space.

Zhang Jun, chief economist at China Galaxy Securities, said that with the RRR of some financial institutions set to be slashed to zero, the previously assumed implicit floor of 5 percent will be pierced.

There is, therefore, greater room for reducing the RRR of commercial banks, with a 50-basis-point cut likely in the third quarter to coordinate with incremental fiscal stimulus and support the economy, Zhang said.

The People's Bank of China, the country's central bank, said on Wednesday that it will reduce the RRR for financial institutions by 0.5 percentage point, bringing the average RRR of financial institutions to a level slightly above 6 percent.

Like previous cuts in recent years, the reduction will not apply to institutions that have implemented a 5 percent RRR, such as small-sized banks and rural financial institutions.

The PBOC, in a rare move, however, announced at the same time an RRR cut to auto financing and financial leasing companies, reducing it to zero from 5 percent temporarily to boost their credit supply capacity for automobile consumption and equipment renewal investment.

International experience suggests that a lower RRR calls for more sophisticated open market operations by a central bank. Currently, China's monetary policy toolkit has been expanded, enhancing the precision of liquidity management and creating room for further RRR reductions, according to a report by CIB research, an institute supported by Industrial Bank Co Ltd.

While China and the United States agreed to slash tariffs after trade talks over the weekend, analysts said there remains the need for further monetary and fiscal easing measures in China as the talks may still undergo twists and turns.

Wang Qing, chief macroeconomic analyst at Golden Credit Rating International, said the PBOC is likely to continue with interest rate cuts and RRR reductions in the second half, as China-US economic and trade negotiations may go through a "complex and winding process" while inflation remains low at home.

In a monetary policy report released in February, the PBOC pledged to continue improving the deposit reserve system and to fully leverage it as a policy adjustment tool, in line with evolving economic and financial conditions.