Wild ride in markets hits Beijing's credibility

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Beijing's failure to stabilize the country's chaotic stock markets is undermining its credibility on the international stage and deepening investor worries about the slowing economy, according to commentators.

Fresh measures to staunch the recent bleeding in mainland equities emerged on Tuesday. More than 200 China-listed companies announced they were suspending share trading, state media outlet Securities Times reported. 700 companies listed in Shanghai and Shenzhen have asked for trading halts or extensions since mid-June, when local markets began their plunge, Reuters said.

The unconventional steps came just hours after Premier Li Keqiang said the government was confident it could deal with economic challenges, according to an official statement, and following a dramatic weekend where Beijing unveiled a number of stabilization efforts, such as halting new share offerings.

"When you have the government doing everything possible to halt declines, that raises a red flag as far I'm concerned," Peter Cardillo, chief market economist at Rockwell Global Capital, told CNBC on Tuesday.

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"Chinese authorities have staked their reputations and credibility on stopping this stock market crash. That could be politically risky if they are seen to fail," echoed Patrick Chovanec, chief strategist at Silvercrest Asset Management.

Indeed, the market-boosting measures don't seem to be working as intended. The Shanghai and Shenzhen Composites slumped 4 and 5 percent respectively in morning trading on Tuesday, chalking up losses of 25 and 30 percent over the past month.

"State-owned newspapers have used their strongest language yet, telling people 'not to lose their minds' and 'not to bury themselves in horror and anxiety.' Despite the People's Bank of China (PBoC) and Chinese government's attempts to dam the outflows, it appears to be futile," said Evan Lucas, market strategist at IG, in a morning note on Tuesday.

Can the stocking up of blue chips save China?
Can the stocking up of blue chips save China?   

Beijing's fruitless attempts comes at an awkward time, as it tries to strengthen its global markets presence. MSCI is widely expected to include A-shares in its global benchmarks in the near future after working with Chinese officials, while the International Monetary Fund is pondering whether to include the yuan in its basket of reserve currencies later this year.

Moreover, the spike in volatility is the latest trigger for foreign investors to avoid China, noted Joe Zidle, portfolio strategist at Richard Bernstein Advisors.

"I would continue to avoid China. There are people saying it's a value and it's cheap but as we step back to look at the economic data, things are getting worse. So, while you have policymakers trying to inject confidence, the underlying fundamentals are also bad," he said.

HSBC's June manufacturing purchasing manager's index (PMI) showed the world's second largest economy stuck in contraction territory for a fourth straight month.

Consequences

If the government is unsuccessful in halting the equity sell-off, two major consequences could arise, despite the minimal wealth effect of equities on Chinese consumption, explained Aidan Yao, senior emerging market economist at AXA Investment Managers, in a note.

Further free-falls could inflict pain on wealth management products of banks, brokers, insurers and shadow banking entities, causing a contagion in the financial system and then in the real economy, he said. It also hurts Beijing's efforts to undertake key reforms, such as financial liberalization, debt deleveraging and revamping state-owned enterprises—the reason why the government engineered a bull market rally in the very first place, he added.

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Despite these dangers, the only real market-boosting measure that could work is one that the central bank likely cannot afford to take.

"The A-share market may not bottom until the government, possibly via the PBoC, becomes the buyer of the last resort," said Bank of America Merrill Lynch (BofAML) in a Monday report . The move would be similar to that of the Hong Kong Monetary Authority in 1998.

However, should the PBoC becomes the main source of market-supporting liquidity, BofAML expects the central bank's credibility to be hurt and for the yuan to come under pressure.

Axa's Yao agrees: "The central bank would not want to risk its balance sheet and credibility by fully committing itself to an equity market bailout ."