‘Big brother’ watches over a fragile China market

Shanghai: Is it possible to stop playing the ‘Big Brother’? Not entirely, if you are the chief coordinator of the Chinese economy.

After promising to step back and allow the market to operate with a modicum of freedom, the People’s Bank of China (PBOC) flooded the money market with funds in an attempt to stop the bourses from sliding down the slippery slope.

On the first day of the week, Chinese equities sank below the psychological barrier-level of 2,000 points, due to a host of complex and conflicting factors — slowing economic growth, confusion over resumption of the reformed IPO process, a market battered by high short-term interest rates and tight liquidity.

Agricultural, oil, port, banking and pharmaceutical shares went on decline, after the government revealed that 2013 GDP growth had slid to 7.7 per cent — a 14-year low.

The relaunch of IPOs also boosted cash demand tremendously this week. IPOs, which restarted in the new year after a 14-month freeze, drove up the demand for short-term funding as investors needed to deposit funds with underwriters to subscribe to new listings. Eight companies listed on Shenzhen Stock Exchange this week, the first batch on China’s smaller bourse since 2012.

Credit crunch concerns are hitting cyclical industries the hardest. China Shenhua Energy, the largest coal producer, slid 1 per cent to a record low of 14.09 yuan (Dh8.47). Anhui Conch Cement, the biggest cement producer here, retreated by more than 3 per cent in both Shanghai and Hong Kong.

All in all, the Shanghai index is already down 5.7 per cent this year.

Emergency liquidity

With a bearish atmosphere overwhelming the market, and the cash crunch growing as the Chinese New Year approaches, the central bank acted in haste.

In an extraordinary move, it provided emergency liquidity to support large commercial banks through its standing lending facility and made a public announcement to pump in 255 billion yuan ($42 billion; Dh153.3 billion) into the money market, to ease panic after Monday’s low opening. The stock market responded and rebounded 0.86 per cent on Tuesday after the PBOC announced its ‘largesse’.

It is virtually unprecedented for the central bank to openly declare its intention to inject or withdraw funds beforehand. Usually, the market learns of these operations only after they are conducted. The liquidity injection came in the form of a hike in the key interest rate that banks charge each other for short-term loans. This interest rate was at a six-month high, due to the seasonal cash demand ahead of the Chinese New Year holiday.

A credit crunch in June 2013 had pounded market sentiment and plunged the benchmark Shanghai index downward by more than 5 per cent in one trading day. There was a second cash crunch and market crash in December 2013, and in both these instances the PBOC had taken a hands-off policy.

This time the bank has every intention of stabilising the money market and meet surging cash demand due to the difficult circumstances that lie ahead.

Crisis of credibility

The fact that the Shanghai stock index dropped below 2,000 suggests that market confidence is weak despite all the reform rhetoric. Additionally, there is a crisis of credibility due to impending default cases and the central bank has little option but to try and minimise a potentially damaging situation.

One of the largest banks of China has been embroiled in a possible wealth management product default case with a non-banking financial entity called the China Credit Trust, a shadow lender, according to various media reports. It is feared that a potential three billion-yuan default could trigger a ripple effect in China’s infamous ‘shadow banking’ system.

A complicated nexus between banking and non-banking institutions has resulted in billions of yuan worth of loans being forwarded to real estate developers, industries beset by overcapacity and local government financial vehicles. Cracks in this edifice will have tremendous implications on the economy and market, which is why the PBOC is not taking its eyes off money movement.

Despite strong promises of allowing the market to play its course, Chinese authorities realise that experimenting with financial reform is risky; events are hard to predict and the damage harder to contain because of the sheer volume of funds involved. It is likely that pragmatism will preside over ‘open market’ policy for now.