The jolt Premier Li Keqiang delivered to the mainland's financial system emulates a strategy crafted by predecessor Zhu Rongji in the 1990s, inflicting short-term pain in the anticipation of long-term gain.
Li, who took office in March, sent the clearest message yet in the past week that the new leadership team in Beijing wants lenders to rein in credit expansion, depriving money markets of liquidity in the biggest squeeze in at least a decade. Next steps may include tightening that sends some smaller financial institutions into bankruptcy, according to analysts at Nomura.
Zhu's strategy of cutting the size of state enterprises with millions on the payrolls helped set the stage for years of growth in excess of 10 per cent. With a focus now on a slower expansion pace that avoids asset bubbles or bad-loan crises, Li and his team face a possible backlash from indebted local governments and state banks that are among the world's largest by market value.
James McGregor, a Beijing-based former chairman of the American Chamber of Commerce in China and author of the 2012 book No Ancient Wisdom, No Followers: The Challenges of Chinese Authoritarian Capitalism, said: "You've got to use a hammer to change this system. There's no rule of law here, so you've got to use blunt instruments to get party members out there in the financial system to pay attention. This got their attention."
The central bank signalled this week that while it will not let the cash squeeze further stir up money markets, any liquidity support will be focused on banks that are lending to help the economy, after credit expansion outpaced economic growth this year. Li's State Council said last week that the financial system must better support the economy. This week he said Beijing will keep consistency and stability in its policies to stabilise market expectations.
China's overnight repurchase rate, a gauge of interbank funding, fell 40 basis points to 5.6 per cent after the central bank said it would use tools to safeguard stability and tight liquidity would ease. The rate, which touched a record 12.85 per cent on June 20, is still more than double the 2.51 per cent average during the six months to May.
Li, 57, has pledged to open the economy to more market forces and strip power from the government. This "self-imposed revolution" would "even feel like cutting one's own wrist", Li said in March.
Fred Hu, the Beijing-based founder of the private equity firm Primavera Capital Group, said: "Investors are trying to find out if Li, like Zhu, has the courage and will to push for wrenching changes. Zhu's reforms, while unpopular and painful at the time, ultimately delivered tremendous benefits to the Chinese economy."
Li's economic team includes leaders who worked under Zhu in the 1990s, such as the governor of the People's Bank of China, Zhou Xiaochuan, who was a deputy governor from 1996 to 1998, and finance minister Lou Jiwei, a vice-minister from 1998 to 2007. Both played roles that led to China joining the World Trade Organisation in 2001.
Mark Williams, a former British Treasury adviser on China who is now an economist at Capital Economics in London, said while the People's Bank of China's actions this month have been "extraordinarily reckless", Zhou was in a very difficult position given that he does not have authority to make key decisions.
"There will be a lot of angry bankers out there, and a lot of state-owned industry will be questioning what went on," Williams said.
Jiang Jianqing, chairman of Industrial and Commercial Bank of China (ICBC), the nation's biggest bank, said there was no clear direction from policymakers on their goals during the money-market turmoil, Reuters reported. "Those few days, even for us, we were genuinely a bit tense," Jiang said, according to Reuters.
Zhu, as the economy's steward from the early 1990s to 2003, during which he served as vice-premier, central bank governor and then premier, helped slash inflation to 2.8 per cent in 1997 from more than 24 per cent in 1994 while slowing growth in fixed-asset investment. More than 50 million workers were laid off at state-owned enterprises under Zhu's watch.