Liquidity squeeze bleeds equities

The benchmark Shanghai Composite Index plummeted 5.3 percent on Monday to close at 1963.24. It was the biggest daily loss in nearly four years, and the second time that the index had fallen below 2,000 since the 4th of December. Analysts say the recent liquidity squeeze in China's banking sector caused the plunge.

On Monday, bank shares fell by 7 percent on average. The biggest losers included Ping An Bank, China Minsheng Bank and Industrial Bank, all falling by the daily 10 percent maximum limit. Analysts say the plunge is due to lack of investor confidence, following a cash squeeze that has seen banks put the brakes on new lending.

zhao Xiaoli, investment advisor of Shanghai Securities, said, "Today's plunge was pretty irrational, but it still reflects the fact that investors are quite jittery over speculation about a shortage of liquidity in the coming one to two weeks. When there are only a few buy offers in the market, it doesn't take much to trigger a major fall."

There's been virtual panic over a liquidity squeeze, especially after the overnight repo rate, a key gauge of liquidity in China's interbank market, hit a record high last Thursday. But the central bank seems still to not want to shore up liquidity. It said in a circular on Monday that the liquidity level of the financial system was "reasonable" and urged lenders to strengthen their own controls over credit expansion. Some consider the move as showing Beijing's attempt to force China's economy toward more balanced growth by being less reliant on credit-driven investment.

Pan Yingli, director of Shanghai Jiaotong University, said, "We should be on guard against investment bubbles. Otherwise excessive growth will appear in credit and investments, leading to many problems in the credit markets."

Other analysts say the central bank chose not to offer liquidity to banks because it wants to deflate bubbles in the banking sector and the real estate markets. That is expected to put continuing downward pressure on the A-share market in the short term.