On the day China was expected to lower interest rates, its stock markets plummeted by over 2%, surprising analysts who had not anticipated such a move from the People's Bank of China (PBoC) after it had left another key indicator unchanged the previous week.
The PBoC (technically the Communist Party’s Central Financial Commission) decided to keep the one- and five-year loan prime rates unchanged at 3.45% and 4.2% on Monday, offering no explanation, as usual.
The market's reaction to this expected inaction was unexpected, prompting an immediate response from the government, which typically doesn't pay much heed to market fluctuations.
Official TV reports on Monday night announced that the government would implement more forceful and effective measures to bolster market confidence.
State-owned CCTV disclosed that a cabinet meeting convened on Monday in response to the sharp drop in Chinese shares, with the Shanghai market sliding by 2.68% and the Hong Kong market by over 2%.
These declines were not ordinary; the blue chip CSI 300 index fell by 1.6% to reach a new five-year low, marking the most significant fall since April 2022. This caught the government's attention.
"China will consolidate and strengthen the upward trend of the economic recovery and promote the stable and healthy development of the capital market," CCTV reported, citing the cabinet meeting chaired by Premier Li Qiang.
China also plans to inject mid and long-term capital into the market and enhance its "internal stability," according to state media reports.
The CSI 300 has been hitting multi-year lows for several months, and Monday’s statement was the first official acknowledgment of this concerning trend.
As share prices plummeted on Monday, major Chinese state-owned banks took action to support the yuan by tightening liquidity in the offshore foreign exchange market and actively selling US dollars onshore, as reported by Reuters.
Surprisingly, government media reports on Monday failed to mention China's most immediate problem - deflation, which increases the cost of debt. This leads to reduced borrowing by companies and consumers, lower spending, higher debt costs, declining profits, reduced incomes, and liquidity tightening.
This explains why the central bank's most significant move in recent months has been to keep China’s money markets as liquid as possible. Last week, The People's Bank of China injected 995 billion yuan ($US138.27 billion) worth of one-year medium-term lending facility (MLF) loans into some financial institutions, maintaining the interest rate at 2.5% from the previous month.
The central bank refrained from cutting the MLF rate last week when it should have, which could have provided banks with some relief and allowed them to reduce their loan prime rates for borrowers.
Ultimately, the primary beneficiaries of the liquidity injection from last week are likely to be struggling property companies, developments, contractors, and, whenever possible, holders of loss-making mortgages. This, in turn, enables banks to avoid recognizing impaired loans and announcing embarrassing write-downs and losses.