China shares dived on Monday in volatile trade as fears of a regulatory crackdown on the world's hottest stock market offset the central bank's most aggressive move yet to bolster the slowing economy. A cut in banks' reserve requirements announced by the People's Bank of China on Sunday was the largest since the global financial crisis, but markets reacted half-heartedly as traders focused on moves by the securities regulator which they feared could pop a gravity-defying, six-month rally.
Money market rates fell but corporate bond yields were largely flat, while the yuan weakened about 0.9 percent to 6.203 to the dollar by late afternoon. Stocks struck seven-year highs during early trade, but those gains evaporated on concerns that regulators want to cool a market that has already gained more than 80 percent since late November, thanks in large part to borrowed money.
By the close both the CSI300 index of the largest listed companies in Shanghai and Shenzhen, and the Shanghai Composite Index, which tracks all stocks on the Shanghai Stock Exchange, ended down 1.6 percent.
Securities regulators announced on Friday they would allow fund managers to lend shares for short-selling, and ban margin financing through unregulated accounts. "The government wants a slow bull market, not a crazy bull," said Wang Yu, an analyst at Pacific Securities. The Hang Seng index fell 2.0 percent, to 27,094.93, its biggest daily loss since December, 2014. Southbound volumes on the Shanghai Hong Kong stock connect, which have recently helped propel Hong Kong equities to multi-year highs, were also sharply down. The southbound quota utilised 349 million yuan ($56.29 million) or only 3.32 percent of the total 10.5 billion yuan quota on Monday.
Zhang Yunyi, general manager of Shanghai-based hedge fund manager Hongyi Investment, expects the market to consolidate for about two months, after climbing seven weeks straight on hopes that Beijing would pump in more stimulus to lessen the risk of a sharp slowdown in the world's second-largest economy.
Economists are unsure how much of the estimated 1 trillion yuan ($161.2 billion) in cash freed up by the latest 100 basis point reserve cut will find its way into new bank loans and real economic activity.
Many suspect a fair chunk will flow into stocks given their far superior returns. Still, some analysts believe the RRR cut was partly designed to cushion the risk of a sharp blow to markets from the securities regulator's latest ruling. "The decision to lower the RRR now may also have been influenced by concerns about the impact on the stock market of policy changes announced on Friday," Mark Williams, the chief Asia economist at Capital Economics said in a note.
"After a sharp sell-off in futures contracts, the regular later issued a statement that the market 'should not over-interpret the measures'. The result of the RRR cut is almost certain to be a further large run-up in share prices."
Markets had widely expected imminent action following March data last week which showed money supply growth and industrial activity at multi-year lows, with the latter posting its worst year-on-year performance since the financial crisis. But the latest cut was more bigger than expected.
The reduction in the reserve ratio, now at 18.5 percent, follows another cut in February and two interest rate cuts since November 2014, the first of the which ignited the latest stock market rally.
More policy easing is expected if business conditions remain weak, with Beijing looking to defend an economic growth target of around 7 percent this year, which would be the slowest in a quarter of a century.
Policymakers have struggled, however, to bring down real borrowing rates which remain stubbornly high for many firms, as reflected by continuing high bond yields. Short-term rates fell and interest rate swap yields declined on Monday. But spreads between high and low-rated debt barely moved, suggesting that market participants do not anticipate fresh funds will flow to the firms that need them most. Analysts said the RRR cut, which releases more funds held by banks for lending, also was partly aimed at lowering bond yields ahead of a massive planned expansion in municipal bond issuance by debt-laden local governments this year.