Spillover could harm sluggish economy

The boom and bust cycle in China's equities market seems to be taking place much quicker than anticipated, sparking warnings thatstock market turmoil may generate a systemic financial crisis that could spill over into the country's sluggish economy.

Supportive government policies once again failed to prevent the A-share market from free-falling as the benchmark Shanghai Composite Index declined 3.48 percent to close at 3,912.77 points on Thursday.

It was the first time since April that the index closed below the psychologically sensitive level of 4,000 points. About $2.65 trillion in market value has been wiped out in three weeks.

Thursday's decline came after a string of government policies to lift the market, including the securities regulator easingmargin trading rules and the stock exchanges cuttingstock trading fees by 30 percent.

The People's Bank of China also announced an injection of additional liquidity worth 35 billion yuan ($5.66 billion) through open market operations after cutting interest rates and the reserve requirement ratio for banks over the weekend.

But traders did not buy into the supportive measures as they continued to dump stocks and liquidate their leveraged margin positions.

Economists warned that investor panic may continue to spread and generate further selling pressure, which could have a detrimental impact on the country's financial stability and the overall economy.

"Whether the government can prevent a systemic financial crisis from happening will have a direct impact on China's effort for financial innovation," said Guan Qingyou, executive director of the research institute at Minsheng Securities.

"It also matters for social stability and the country's overall economic development," Guan said.

On Thursday, Zhou Xiaochuan, governor of the PBOC, the central bank, said during an internal meeting that China will firmly hold the bottom line to prevent systemic and regional financial risks.

While analysts attributed recent market drops to forced liquidation of margin trading, there is growing speculation that the market has been further depressed by speculators shorting the A-share market.

Tools such as stockindex futures, which are intended for investors to hedge risks, have been used as weapons to slaughter the bull market, said Liu Shuwei, director of the Chinese Enterprise Research Center at the Central University of Finance and Economics.

Some analysts said that the recent market turmoil may be a hard-learned lesson for regulators and investors and may lead to a more cautious attitude by Beijing toward the country's financial innovation and liberalization.

The China Securities Regulatory Commission has launched an investigation into investors who use stockindex futures to short the market.

The probe will target market manipulation, and law enforcement personnel will crack down on illegal market activities. Those involved in crimes will be handed over to the public security departments.

Bloomberg also reported that the regulator may put a hold onfutures trading to prevent possible market manipulation.

Analysts believed that it is highly likely that the government will roll out more measures including a reduction of stock stamp duties and a suspension of new share sales to prop up the market.

While government measures may help calm the market in the short term, some analysts expressed doubts over the administrative intervention as it may sow seeds for an even greater crisis in the future.