China's second market disruption in less than four months has sparked questions about the new government's management of economic policy, analysts say.
On June 25, the People's Bank of China (PBOC) tried to ease market fears of a liquidity crisis following a two-week spike in interest rates and a plunge in share prices to 2009 lows.
"In recent days, the central bank has provided liquidity support to some financial institutions that meet the demands of macro prudence," the PBOC said in a statement on its website.
The announcement was seen as the first sign that the bank had injected at least some funds into the banking system after shutting off the spigot abruptly in early June, leaving lenders on edge.
Just as suddenly, the bank signaled it had turned the support tap back on.
"We'll closely monitor the change of liquidity within the banking system going forward [and] flexibly adjust liquidity management based on international payments and the liquidity demand-and-supply situation," said Ling Tao, deputy head of the PBOC's Shanghai branch, as quoted by Bloomberg News.
The conciliatory terms came one day after the PBOC appeared to rebuff calls for help from cash-strapped banks, driving overnight lending rates to record highs of over 13 percent and spurring rumors of default.
"Currently, overall liquidity in the domestic banking system is at a reasonable level," the PBOC said in a tight-fisted statement on June 24.
The Shanghai Composite Index responded with a one-day drop of over 5 percent. Shares were down nearly 20 percent from February levels, according to The New York Times.
In Li Keqiang's lead
The PBOC is believed to be following the lead of Premier Li Keqiang, who has been trying to break the easy-money cycle that has bloated wasteful enterprises, local financing vehicles, and the shadow banking industry, which Moody's Investors Services estimates to be worth 29 trillion yuan (U.S. $4.7 trillion).
The new government that took office in March has won praise for trying to put China on a more sustainable growth path after years of relying on stimulus programs, infrastructure spending, and property development.
But the government's prescriptions for the slower-growth economy have at times appeared ill-considered, badly implemented, or crude.
"I think it's a sign of, basically, inexperience," said Gary Hufbauer, senior fellow at the Peterson Institute for International Economics in Washington.
"It probably takes a long time for authorities who were brought up in a command-and-control political environment to adjust to a more market-oriented environment," Hufbauer said.
The liquidity squeeze is the second surprise move that has backfired since March.
On March 1, the State Council sowed widespread confusion among home buyers and property investors by announcing plans to slap a 20-percent profit tax on housing sales.
The order gave local governments one month to issue their own versions of the measure, producing a patchwork of rules which have since been largely ignored.
But in the meantime, the order that was intended to discourage price hikes instead drove prices higher as buyers rushed to beat the deadline for a tax that apparently was never imposed.
David Bachman, a political science professor and China specialist at University of Washington, said the liquidity crunch is another case of unintended consequences.
"It's certainly clear that the bank is doing things that don't correctly anticipate how markets and others will react," Bachman said.
"The bank seems to have attempted something that may have been laudable, but it produced the exact opposite effect of what they were intending," he said.
Cracking down on wealth management products
According to a rare critical analysis by the official Xinhua news agency, the PBOC backed off after "the market reacted to [the] regulators' call in a way that was the opposite of what regulators had hoped for."
The PBOC's aim was to reduce the risks of shadow banking and crack down on wealth management products (WMPs), which offer well-heeled clients higher short-term rates of return at higher risk.
Fitch Ratings service has estimated that there were 13 trillion yuan ($2.1 trillion) of WMPs outstanding in March, posing a serious leverage issue for the economy.
The liquidity shutdown left banks scrambling to meet their payment obligations at high WMP rates. Banks were left with little choice other than to double down on WMP bets.
"In desperate need of cash, banks rolled out massive WMPs to attract deposits, and the yields of these investments grew much higher than previous ones, thus posing greater risks," Xinhua said.
The threat to the banking system and the economy may now be greater than the problem that the government was initially trying to solve.
Bachman said the sequence of events may also suggest "factional action" within the government rather than mismanagement by a single authority.
"One side is trying to advance a set of issues and perhaps gets the jump on others by announcing them," he said.
But these forces may not be prepared, while the other side overreacts and tries to sabotage the policy, forcing the initiators to back away.
If that is the case, world markets could be in for months of abrupt changes and back-and-forth battles as China struggles to implement its economic shift.
"The leaders are still feeling their way in terms of interaction with the markets," said Gary Hufbauer.
China's economic announcements have tended to create more sudden shocks than those of Western governments, he said.
"In Europe and the United States, central banks and the finance ministries usually make a lot of effort to gradually inform the market of changes in policy," said Hufbauer.
"In China, they don't do that kind of preparation to the same extent," he said. "So, the result of these abrupt announcements is quite a shock effect in the market instead of a slow transition or adjustment over time."