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"Senior policymakers realise that, because of the leverage in the system, stock market declines create a ripple effect that could damage the wider economy, so this is all about preventing a spreading panic that could trigger a systemic crisis," says Lu Ting, head of research at Hong Kong-listed mainland brokerage HTSC.

Update | Investors still not convinced by Beijing’s bid to end US$2.8 trillion market rout

Rally fades as analysts worry further falls could set off a systemic crisis and push back reforms

Restoring battered investor confidence is the cornerstone of Beijing's sweeping response to a US$2.8 trillion domestic stock market rout that could yet set off a systemic crisis and derail reforms to transform the country's economic model.

The brevity of a relief rally at the start of trade and a mixed close shows investors are yet to be convinced by the slew of measures announced after a weekend meeting of the State Council, China's cabinet, chaired by Premier Li Keqiang .

"Senior policymakers realise that, because of the leverage in the system, stock market declines create a ripple effect that could damage the wider economy, so this is all about preventing a spreading panic that could trigger a systemic crisis," Lu Ting, head of research at Hong Kong-listed mainland brokerage HTSC, told the .

"The issue now is about implementation and whether or not money starts coming back to the market."

In yet another reiteration of the government's confidence, the premier told a gathering of overseas Chinese in Beijing that economic development in the first half of the year was "within reasonable range".

"We are confident we have the capability to handle different kinds of risks and challenges to promote the sustainable and healthy development of the economy," he was quoted by state-run CCTV as saying.

An initial 7 per cent rally for Shanghai and Shenzhen A shares in response to measures that included liquidity support for the state-backed margin lender China Securities Finance Corporation from the central bank, faded fast yesterday.

The Shenzhen Composite Index - broadly composed of technology and private sector companies - ended the day down 2.7 per cent. Its Shanghai counterpart, tracking huge state-owned enterprises and the nation's top finance firms, managed to hold a gain of 2.4 per cent.

The People's Bank of China (PBOC) move came after the mainland's biggest brokerages agreed to set up a 120 billion yuan (HK$150 billion) fund to prop up the market and promised not to sell shares in proprietary accounts while the Shanghai index remained below 4,500 points - roughly 20 per cent above its current level. Some 25 mutual fund firms also pledged to inject capital into vehicles they manage.

Analysts at Bank of America/Merrill Lynch likened the package to the "big bazooka" measures promised in 2008 by then US Treasury Secretary Hank Paulson to stop the spreading crisis that was tearing at the heart of the global financial system.

Having previously argued that the bottom for A shares was unlikely to be seen unless the government, possibly via the PBOC, became the buyer of last resort, the bank's equity strategists see the weekend moves as being a step in that direction - and one fraught with risks.

"We assess that there is still a fairly high chance that [the] market may fall sharply again at certain point over the next few months, unless the PBOC makes an open-ended commitment to support the market," they wrote in a note to clients.

"If the PBOC becomes the main source of market-supporting liquidity, we expect the central bank's credibility to be hurt and the RMB [yuan] may come under pressure."

The bank's bottom line was to advise clients to sell A shares into any rally, particularly those of brokerages.

Broking firms are at the heart of a web of margin finance - loans to buy stocks - that currently totals around 2 trillion yuan officially, with an estimated 3 trillion yuan more borrowed through unofficial channels by many of the country's 90 million registered investors who generate about 80 per cent of daily stock market turnover through 257 million equity investment accounts.

The mainland's still tightly managed capital account and domestically focused financial sector mean that the unwinding of huge debt-finance trades has little risk of triggering international market contagion, but the painful hit at home could deal a serious blow to the mainland economy, which currently generates around 30 per cent of global economic growth.

"A stock market crash would be undoubtedly painful, which if materialising, could shave 0.5 to 1 percentage point off real GDP growth in the following 12 months. In that case, policy easing, both monetary and fiscal, would have to step up," said Yao Wei, chief China economist at investment bank SG.

More problematic still, in her view, is the risk that the government reins in financial market liberalisation in response - a move that could snuff out a nascent shift towards stable equity financing needed by the fast-growing private sector, which creates the bulk of new jobs each year in the mainland, but which is chronically underfunded by a state-driven banking system that lends mainly to government-backed firms.

Analysts widely regard a move towards market financing by Beijing as key to creating a vibrant, innovation-led, consumer-driven economy to replace an export, manufacturing and investment-dominated economic model that is running out of steam.

A market failure might also put at risk President Xi Jinping's ambition to realise the so-called "Chinese Dream" - broadly defined as a national rejuvenation and the creation widespread prosperity.

"The A share market has become the ultimate stage for political and economic power struggles," according to Sean Darby, the Hong Kong-based chief global equity strategist at brokerage Jefferies.

"With millions of investors' household wealth on the line, this market turmoil also puts confidence in the financial system and Chinese government at risk," he wrote in a note to clients. "With reform and the China Dream at stake, this is a battle China cannot afford to lose."

This article appeared in the South China Morning Post print edition as: Investors unconvinced by Beijing’s bid to end market rout
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