China struggles to shore up stocks, stabilise yuan

China moved to shore up shaky sentiment today, a day after its stock indices and currency yuan tumbled, rattling markets worldwide, but analysts warned investors to buckle up for more wild price swings.

Stocks fell more than 2 per cent in early trade, prompting fears that exchanges were set for a second day of panic selling after a 7 per cent dive on Monday set off a new "circuit breaker" mechanism, suspending trade nation-wide for the first time.

But both the central bank and the stock regulator reacted quickly, and major indexes clawed back some ground by early afternoon, albeit in skittish trade.

The People's Bank of China (PBOC) poured nearly $20 billion into money markets, its largest cash injection since September, and traders suspected it was using state banks to prop up the yuan at the same time.

The China Securities Regulatory Commission (CSRC), for its part, announced it was planning new rules to further restrict share sales by major stakeholders in listed companies, and said it would further tweak the circuit breaker mechanism.

How long any reprieve will last is still in question.

In a dilemma similar to the US Federal Reserve's recent tapering of its stimulus programme, Beijing is trying to orderly unwind a massive and unprecedented stock market rescue last summer, while pressing ahead with reforms to allow markets to have a greater say in determining the yuan's value.

Its heavy handed approach to the stock market crash and its surprise devaluation of the yuan in August had called its policymaking into question and sparked global market volatility.

Keeping China's notoriously volatile and speculative stock markets stable will be tricky. Some market watchers say the government's interventions have kept stock valuations excessively high given the cooling economy and falling profits.

Government actions have also suppressed trading volume, leaving the market more susceptible to big price swings, and discouraged foreign investors who tend to hold stocks longer than hit-and-run local retail investors.

"We've been waiting for a market drop like this for a long time," said Samuel Chien, a partner of Shanghai-based hedge fund manager BoomTrend Investment Management Co.

"The economy is poor, stock valuation is still high, and the yuan keeps sliding, showing capital outflows are accelerating. The market drop is overdue."

Indeed, retail investors who spoke to Reuters said they were steering clear of stocks, having already been burned by this week's experience.

Yuan speculations
China is also wrestling with market expectations that it will allow further depreciation of the yuan to shore up weak exports, a scenario many traders believe is inevitable as the economy slows and more investors pull capital out of the country in search of better returns elsewhere.

Authorities let the yuan weaken 4.7 per cent against the dollar last year, a record yearly loss. It slipped further to fresh 4-1/2 year lows on Monday, which some blamed for aggravating Monday's stock market slump.

 While the onshore yuan market has stabilized in response to central bank blandishments, the offshore yuan continues to price in deeper discounts; trading at 6.6373 per dollar, 1.7 per cent weaker than the onshore currency.

The gap is so large as to make them effectively different currencies, increasing risks for companies and traders.

It also increases the likelihood of market-distorting arbitrage strategies, which the PBOC has shown of being concerned about. It recently moved to suspend foreign banks suspected of implementing aggressive strategies to profit from the rate difference and more enforcement is expected.

If Tuesday's policy-induced market respite proves temporary, regulators might have to freeze new share offerings again, extend a ban on certain share sales and keep the "national team" of brokerages and asset managers on the hook to keep buying and holding stocks at a loss.

This could entail the further postponement of already delayed reforms, such as moving to a US-style IPO registration system that would reduce opportunities for corruption and regulatory meddling.

Such an eventuality would further dent confidence in the China Securities Regulatory Commission and in the wider financial regulatory framework to manage increasingly complex markets as the economy slows.