Exit strategies used to be the preoccupation of Pentagon planners. Nowadays, it’s more a province for central bank watchers, since the Federal Reserve gorged on trillions of dollars of mortgage and government debt.
And in that economic realm, China has just added a new conundrum. The dependence of the nation’s stock market on official support was exposed Monday with the biggest drop since 2007 amid speculation aid had been dialed back. The Shanghai Composite Index fell 1.7 percent Tuesday even after China pledged efforts to “stabilize” the market.
China’s actions in the past month add a new asset to those whose prices depend on policy-maker fiat -- from European and Japanese government bonds to U.S. mortgage securities.
The 2013 taper tantrum that followed speculation the Fed would slow bond buying hit emerging markets hard and showed what can happen when investors expect policy makers to reduce stimulus. For China, failure to eventually withdraw from emergency measures would prevent the communist leadership from achieving its goal of letting markets play a decisive role.
“Investors everywhere have been coddled by policy makers in recent years, making it hard for officials to exit,” said Frederic Neumann, co-head of Asian economic research at HSBC Holdings Plc in Hong Kong. “A hard-nosed approach, possibly leading to a further slide in markets, would help establish sound policy over time. But the temptation remains to put off the pain a little longer.”
The People’s Bank of China became ensnared in the stock-market rescue by extending funds to a broker-lending facility, saying early this month it will provide “ample liquidity” to aid the nation’s tumbling equities. In an unusual move Tuesday, it issued a statement before a mid-year meeting with local PBOC chiefs, saying it will “stabilize financial market expectations and continue to support the real economy.”
The Shanghai Composite indeed showed some stabilization last week, before sliding Friday. It was little changed as of 11:04 a.m. local time Wednesday.
How to wean Chinese investors -- who outnumber Communist Party members -- off that liquidity will be the tricky part. The challenge of restoring stock-market stability in the world’s No. 2 economy coincides with moves in the biggest one to begin an interest-rate increase cycle for the first time since 2004.
“The Fed’s been a source of volatility since the third quarter of last year and now it’s China and the U.S.,” said Tim Condon, head of Asia research in Singapore at ING Groep NV. “The Fed’s doing its best to show it’s not going to be a source of uncertainty and now China’s in completely the same predicament.”
After more than quadrupling its balance sheet, the U.S. central bank wrestled with how to withdraw stimulus to the American economy. While the Fed has kept its holdings at around $4.5 trillion for almost a year, Chair Janet Yellen has signaled that a rate rise is coming by year-end.
Bank of Japan officials also have discussed maintaining a large balance sheet even after the central bank achieved its 2 percent inflation target. Critics have warned that the BOJ’s unwillingness to taper its record bond purchases is enabling the government to refrain from the fiscal consolidation that’s ultimately needed to avoid a debt crisis.
In China, President Xi Jinping’s government initially sought to rein in leverage that soared under the previous leadership team that began turning over the reins in 2012. When local governments complied and the result was a slide in infrastructure investment and the weakest economic growth since 1990, policy makers changed their tune.
Earlier this year, officials told banks to keep up their lending to local authorities, who for their part were given a green light to issue bonds to refinance higher-cost debt. Now, the stock-market rescue brings more uncertainty to the mix.
With global growth already vulnerable to a further slowdown in China’s expansion, the equities sell-off makes the risk of a hard landing or protracted slump a key threat, said Rajiv Biswas, Asia-Pacific chief economist at IHS Global Insight in Singapore.
With little sign of a bottom in the market yet, Chinese authorities may have little option but to intervene further.
“Many people will just say ‘I’m out of here,’” said Condon at ING. Policy makers “may get it right but they may get it wrong and investors may feel that’s just too much uncertainty to bear.”
— With assistance by Kevin Hamlin, and Enda Curran