Short sharp shock

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.

Xinhua said in a commentary on Wednesday: "For the blessing of a more sustainable economy, banks are the first, but certainly not the last to suffer hardship."

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.