By Gabriel Wildau
SHANGHAI, June 25 Chinese stocks plunged to
their lowest since the global financial crisis on Tuesday after
the central bank turned off the taps for cheap cash, but markets
rallied late in the day on hopes authorities would step in to
prevent a crisis.
The immediate fears of a cash crunch that saw banks scramble
for funds as interest rates spiked last week have moderated, but
the expectation conditions will remain tight has raised doubts
about banks' earnings and the outlook for the whole economy.
The sudden squeeze, and the People's Bank of China's (PBOC)
tough message that there was enough cash and it was up to banks
to manage it and control lending better, hit particularly hard
the smaller banks that rely on central bank funding.
"In the long term... this represents a new policy decision
by Premier Li Keqiang, so the market will no longer be as loose
as before," said Cao Xuefeng, head of research at Huaxi
Securities in Chengdu.
In a panicky stock market, sentiment swung wildly. At one
point on Tuesday, the CSI300 of the leading Shanghai
and Shenzhen listings was down as much as 6 percent at its
lowest since January 2009, before ending down just 0.3 percent.
The market had fallen 6.3 percent on Monday.
Reports of outages at cash machines of some banks added to
the nervousness, with the index of financial stocks on the
Shanghai exchange falling 7 percent at one point before
recovering to close down a mere 0.1 percent.
"There is a problem with cash flow and confidence right
now," said Zhou Lin, analyst at Huatai Securities.
"From the perspective of investors, the danger is that the
value of shares will continue to fall. If the economic situation
continues to worsen, then banks' profits are likely to fall."
In the money market, short-term rates continued a broad
moderation, after they had shot up last week when the central
bank refrained from helping banks tide over a tighter spell in a
seemingly deliberate move to curb credit flowing to China's vast
"shadow banking" system.
Overnight and 7-day rates eased again on Tuesday after the
central bank did not drain funds, but weighted-average rates of
over 5.8 percent and 7.4 percent
respectively were still well above long-run levels.
Underscoring the tight conditions, there were spikes to 15
percent and higher for some deals during the day.
RISK WORTH TAKING
In addition to worries about banks as credit tightens,
investors are also concerned that funding for many companies may
dry up, forcing the world's second-largest economy to slow more
than expected, sending ripples through other markets in the
Several economists, however, praised the authorities and
said it was a risk worth taking in order to steer the world's
second-largest economy away from debt-fueled investment in
infrastructure and property to a more sustainable path.
"The liquidity squeeze is the first real economic test for
China's new leaders, to prove their willingness to overcome
tough economic issues not with words, but by their actions,"
Zhiwei Zhang, a China economist for Nomura in Hong Kong, said in
a research note.
"If the new leaders maintain their current approach, we
believe it will add downside risk to growth in 2013, but in our
opinion this would help reduce systemic financial risks,
supporting long-term sustainable growth."
For decades China's rapid economic ascendancy has been
powered by heavy investment fuelled by cheap, readily available
credit made possible by vast savings trapped in the banking
system at artificially low rates.
Most recently, a massive debt-fuelled spending spree in the
aftermath of the Lehman Brothers collapse in 2008 and the global
financial crisis helped China bounce back quickly and was
credited for helping the global economy avoid a severe
But with most analysts estimating China's total
non-financial debt at around 200 percent of economic output and
increasing amounts of it being funneled through the shadow
system of wealth management products and trust funds, the new
leadership of President Xi Jinping has been trying to cool
Market turbulence of the past week and violent and nervous
investor reaction, however, highlighted the risks of Beijing's
new approach to its debt headache.
"We believe the biggest risk comes from the PBOC potentially
mishandling the situation," Bank of America Merrill Lynch
analysts said in a note.
"In our view, dealing with banks in breach of regulations
should be done by improving prudential regulations rather than
engineering an interbank credit crunch which could potentially
backfire should banks lose mutual trust."