China's tumbling stock markets: Will the country need the 'wet nurse' again?

Beijing has insisted it will not rescue China's tumbling stock markets with liquidity injections. But analysts are unsure whether to believe the promise

One of China's national emblems is the Giant Panda. But a rather less appealing variety of bear is now stalking the Middle Kingdom. The value of the Shanghai Stock Exchange is down by around a fifth since its February peak. A rapid fall of such a magnitude fits one of the usual definitions of a bear market.

The proximate cause of this market strife has been a vicious spike in inter-bank lending rates in recent weeks.

When this sort of financial stress has emerged in the past the Chinese central bank has rushed to the rescue with buckets full of short-term liquidity in order to preserve stability. But the monetary authority has been sitting on its hands this time around.

The People's Daily newspaper, which is understood to have close links to the Communist leadership, wrote in an editorial early yesterday that it was not the job of the central bank to play "wet nurse" to the stock exchange by providing liquidity to banks and other financial institutions that have over-stretched themselves in recent years.

Well, up to a point. The People's Bank of China did yesterday belatedly attempt to calm things down by releasing a statement pledging to help distressed financial institutions if absolutely necessary. "If banks have temporary shortages in their planned funding, the central bank will give them liquidity support," it said.

"If institutions have problems in managing their liquidity, the central bank will apply appropriate measures under the circumstances to maintain the overall stability of money markets." The central bank also added that it had already provided support to some banks, although it did not name the institutions in question.

So will more overt and comprehensive forms of help from the authorities be forthcoming to quell the storms and restore confidence to investors in the world's second largest economy? Analysts are divided. Some see recent events as a sign that the Beijing authorities are acting on their promises to wean China off its reliance on investment spending, fuelled by cheap credit, and to rebalance the economy towards more sustainable sources of growth. The introduction of some painful market disciplines on weak lenders, particularly those operating in the shadow banking sector, in this analysis, is the necessary first step.

"The episode is arguably the strongest sign yet that the leadership is willing to suffer short-term economic pain if necessary to achieve more sustainable growth" argues Mark Williams of Capital Economics.

"What the market is fearing is that the government and the People's Bank of China want to really continue with the reforms and a lot of the smaller companies, smaller banks may not survive," said Daphne Roth of ABN Amro Private Bank.

But Christian Schulz of Berenberg Bank feels the authorities would probably step in much sooner, rather than later, to avert any scenario in which unemployment would rise and unrest could potentially threaten the regime. "While it is convinced of the salutary effects of tougher policy, China is also unlikely to risk a serious financial crisis" he said. In other words, expect the wet nurse to return promptly if things look like they could get truly ugly.

Kathleen Brooks of said that yesterday's statement from the People's Bank showed that the authorities had already effectively caved in. "China is starting to look less like Europe's Angela Merkel and a bit more like the Fed, always at the ready with a life-saving injection of liquidity" she said.

In truth given the traditional opacity of the Beijing regime no one can be sure. It is perfectly possible that Xi Jinping's relatively new administration is divided about how to proceed. But the greatest mistake that an outsider could make, as this high-stakes drama plays out, is to assume that China's economy runs by similar rules as those in Europe or America.

The truth is that they are worlds apart. China's economy is dominated by state-owned enterprises, at least 30 per cent of firms are ultimately controlled by the government.

This is true of those listed on the Shanghai Stock market. The wider Chinese economy is still largely closed. Beijing retains capital controls, which limits the amount of money that can flow in an out of the country.

This, combined with controls over interest rates, means the authorities can effectively mobilise its population's savings to make cheap loans to industry and pump up growth impressively. That is how China has largely expanded its economy since the global financial crisis. Even if the administration in Beijing is determined to shift away from this unsustainable model, it will be extremely difficult given the number of vested interests who benefit from it.

We have an interest in how all this plays out. China is projected by the International Monetary Fund to provide the biggest single contribution to global growth in 2013.

If the Chinese motor fails, we will all feel the impact.

Difficult to see who calls the shots in China

The uncertainty about how Beijing will respond to the market turmoil is compounded by the fact that it is often difficult to see who is calling the shots. Interest rate decisions are made by the State Council, rather than the People's Bank of China.

The People's Bank used to control commercial banks' reserve requirements, but those powers now seem to have been transferred. The State Council, the equivalent of the Cabinet, also seems to have authority over managing market liquidity.

To understand decisions, investors have to pay regard not only to the statements from the central bank, but also official mouthpieces such as the People's Daily and the Xinhua news agency.

Ben Chu's 'Chinese Whispers: Why everything You've Heard About China is Wrong' is published in October by Weidenfeld & Nicolson

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