The dramatic one-day wobble in Chinese share prices highlights the tricky task facing regulators as they try to prevent a dangerous bubble in a market that has grown 130 percent in a year, analysts said.
They said that while Tuesday's 8.84-percent plunge in the Shanghai Composite Index suggested the government may have miscalculated, the sell-off was also partly caused by profit-taking after a long period of gains.
"The challenge is that they have to combat generally bullish sentiment and ample liquidity," said Stephen Green, a Shanghai-based economist for Standard Chartered.
"So they have to somehow calibrate the rhetoric and the policy actions to keep a lid on this, while not triggering a collapse," he said.
Tuesday's steep drop was blamed on investor fears over a rumored capital gains tax on securities investments and the government was quick to quell those rumors in the state press yesterday.
"There will be no capital gains taxes," the Shanghai Securities News quoted China's State Administration of Taxation as saying.
So as Asian stocks fell sharply yesterday, hit by heavy losses in Shanghai and fears of a US economic slowdown, China's bourses rebounded around 4 percent, suggesting investors had already regained their composure.
Tim Condon, chief economist at ING Barings, said that although Chinese share prices were unquestionably overvalued, the government was monitoring carefully, keen to ensure it does not provoke the kind of meltdown it has in the past.
"The report tells us that the authorities do not want their equity markets to crash," Condon said.
As yesterday's trade wore on, the stock markets' record fall the day before looked increasingly like a blip, and the bourse was already stabilizing.
The sharp fall on Tuesday came after a sustained period of strong gains, with the Shanghai index rising in 22 out of the last 25 weeks and breaking the 3,000 points mark for the first time last Monday.
That in itself was a key reason for the sell-off as it provided investors with a technical excuse to pocket gains, Standard Chartered's Green said.
"This was investors getting nervous around a major level," Green told clients.
Only 20 months ago China's bourses were floundering at eight-year lows, seemingly incapable of recouping losses provoked by regulators' decision to hammer through a plan to convert state-owned shares into public ones.
But the much criticized overhaul eventually triggered the positive interest that has led to the unprecedented gains supported by earnings from the country's massive exports that has created the world's fourth-largest economy.
Total capitalization on China's two bourses in Shanghai and Shenzhen has climbed to about US$1.5 trillion, a dramatic turnaround from when value that in mid-2005 dipped below US$400 billion.
Nevertheless many analysts do believe Chinese equities are sharply overvalued, with price-to-earnings ratios, a common measure of the value of stocks, up at around 40, or double what is considered healthy.
"The fundamental reason for an A share market correction is its stretched valuation," said Jun Ma (
Ma added that while the correction could lead to a further "healthy" 15 to 20 percent correction, the equities' declines had little do with the overall health of the Chinese economy.
"We do not see any significant impact of this market correction on China's real economy."
Lu Fangxing, an analyst with Chinalion Securities (
"Clearly this was a sell-off from institutional selling," said Lu, adding that he believed the downward trend was unlikely to last long.
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