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What's with China's mixed policy messages?

The People's Bank of China in Beijing's financial district.
Tomohiro Ohsumi | Bloomberg | Getty Images
The People's Bank of China in Beijing's financial district.

Beijing's micromanagement of the turmoil in equity markets is only worsening confidence in the world's second largest economy as a series of contradictory policy measures creates further confusion.

A surprise decision on August 11 to make the yuan more "market oriented" was followed by a press conference two days later where People's Bank of China (PBoC) vice governor Yi Gang said the central bank would "effectively manage" the exchange rate when volatility arises.

Fresh developments this week also appeared to further reverse the PBoC's decision for a market-oriented currency. The PBoC will tighten rules on currency forwards starting from October in an attempt to limit further depreciation, sources told Reuters on Wednesday.

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"It seems pretty clear that there are deep disagreements at the highest levels of the Chinese government over what to do with the equity markets," remarked Angus Nicholson, market analyst at IG.

The policy flip-flops come at a delicate time for the Chinese economy, whose once buoyant growth is now sputtering. Signs of a slowdown have exacerbated a selloff in everything from the Australian dollar to crude oil in recent days.

Beijing's divergent actions are perhaps best reflected in its handling of the stock market crash that's erased 30 percent off Shanghai and Shenzhen shares in the past three months.

On August 14, news emerged that China Securities Finance Corp, the state agency responsible for supporting share prices, would refrain from increasing equity holdings barring unusual volatility and systemic risk. But last week, a group of state financial institutions tasked with purchasing blue-chip stocks—known as the "national team"—reportedly ramped up its efforts, triggering combined gains of 10 percent on the Shanghai Composite Thursday and Friday

Moreover, Monday saw the China Securities Regulatory Commission (CSRC) announce a push for further mergers and acquisitions, dividends and buybacks in another attempt to boost stocks.

To be sure, this marks a slight improvement, noted Danyi Yang, senior analyst at Frontier Strategy Group. "It seems like they're turning to more sustainable intervention, compared to their earlier intervention methods of direct share purchases."

Still, all this has only exacerbated volatility, drawn international criticism and scared investors away from a stock market hoping to gain entry into the MSCI Emerging Markets Index.

"Some have even begun to question whether the Chinese government has lost control," Standard Life Investments said in a report on Wednesday.

Behind the confusion

The mixed messages are rooted within China's fundamental dilemma of managing its state sector and free market reforms, explained Yang.

"It's a tug of war between China's long-term economic goals and the short-term market situation. The confusion also reveals the divergence of views within the government itself."

Beijing's goal of opening up its economy and embracing international standards, reflected by its wish to join the International Monetary Fund's reserve currency basket, necessitates financial market liberalization but wild market swings require more state control to reassure retail investors, she noted.

The opaque nature of the government also fuels policy confusion.

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"China's government is no monolith, and many departments and organizations can pursue policies counter to each other," IG's Nicholson said.

"As the dust begins to settle over the market crash over the next few months, it will become increasingly clear who the winners and losers in the government have been."

He believes the CSRC, the securities regulator, could have the most to lose.

"The concern for the CSRC is if it's perceived to have failed in its primary task of regulating the equities markets, it could lose further funding and power in this sphere to the PBoC."

Indeed, former CSRC head Guo Shuqing got a taste of government disapproval back in 2013 when his recommendations for reduced state authority over markets got him replaced by then Bank of China chairman Xiao Gang.

So, how much longer will the uncertainty last?

Beijing needs time to restore confidence so officials are unlikely to relinquish control over the next 6-12 months at least, according to Yang.