Since the release of the December PMI data, China’s stock market has experienced a sharp pullback over three consecutive trading days, stirring the nerves of market participants. Following the Politburo meeting on September 26, macroeconomic data showed an upward trend for three months, but the December PMI revealed a weakening ability for macroeconomic expansion. The “boosting of the capital market” proposed for the first time during the September 26 meeting led to a swift recovery in Chinese stocks from their lows, with the Shanghai Stock Exchange breaching the key 3,300-point level. The year-end economic work meeting revised the goal of boosting the capital market to stabilizing both the real estate and stock markets, setting high targets for financial stability. From a financial stability perspective, the primary responsibility lies with the People’s Bank of China (PBOC) and the China Securities Regulatory Commission (CSRC). The PBOC created two capital market tools to stabilize the financial market, and in efforts to stabilize the bond market, it also introduced a buyout reverse repurchase operation. The overarching logic here is to provide a channel for excess liquidity in the bond market to flow into the stock market. In recent months, the PBOC has continuously expanded the scope of these tools and reduced their costs, attempting to balance the yield on government bonds with the price-to-earnings ratio of stocks. Meanwhile, the CSRC has consistently published documents advocating for the construction of a high-level capital market. Under the protection of these numerous financial stability measures, the Shanghai stock market has remained around the 3,300-point level, but an overall breakout has been difficult. This is largely due to the banks balancing the index, and many small and mid-sized stocks are still underperforming compared to October 8.
The volatility in the stock market is impacted by policy expectations, meeting outcomes, and macroeconomic data. Last Friday, under pressure from significant fluctuations in the stock market, the PBOC proposed timely reductions in reserve requirements and interest rates. Compared to the two capital market tools, these actions represent the PBOC’s more crucial counter-cyclical adjustment measures. The use of reserve cuts and interest rate reductions should theoretically be tied to macroeconomic data, and in recent years, such tools have only been triggered when the PMI has remained below 50 for two to three consecutive months. The PBOC’s actions last Friday clearly went beyond the scope of financial stability and were a reluctant use of macro-control tools to stabilize the stock market. The responsibility to stabilize both the real estate and stock markets has become a political duty for the PBOC, and when cornered, it had no choice but to deploy such tools. On the one hand, there is the continuous decline in bond yields and the spillover of liquidity; on the other, the stock market’s retreat due to lower economic expectations. The central bank had no option but to inject liquidity into the market to stabilize stocks, which, in turn, provided more ammunition for the bond market.
We observe that the responsibility for macroeconomic regulation and financial stability should not rest solely with the PBOC. The Ministry of Finance and other departments should also bear their corresponding responsibilities. Given the high probability of financial stability events, fiscal policy should gradually shift towards greater flexibility and higher frequency. Traditionally, fiscal policy has followed a budget and quota system, where annual behavior is determined by setting budgets and issuing quotas at the beginning of the year. This approach makes it difficult to stimulate market expectations effectively. It is akin to a situation where the supply of government bonds is limited each year, and the issuance of bonds cannot regulate the bond market or influence overall financial stability. If more flexible tools could be adopted, such as last Friday’s announcement by the Ministry of Finance to increase the issuance quota of ultra-long-term special government bonds and local bonds, it would align with monetary policy to help achieve financial stability. Clearly, under the current macroeconomic environment, the PBOC’s interest rate policies are significantly lagging behind market performance. Since the PBOC bears the responsibility for the stable operation of commercial banks, the Ministry of Finance’s policy to inject capital into commercial banks has yet to be implemented, and without a solid cushion for commercial banks, the PBOC dares not undertake large-scale interest rate cuts. Therefore, the recently proposed reductions in reserve requirements and interest rates are limited to around 10 basis points, and if every financial stability intervention is met with market expectations that do not improve, this approach will eventually hit a dead end. The root issue still lies in economic growth, employment, and expectations. Even if the National People’s Congress approves several trillion yuan in funding from the Ministry of Finance, what will the economic growth situation look like in 2026? Whether for individuals or enterprises, when considering loans for the next 1-2 years, they will have to factor in the economic conditions of 2026. The key remains how to enhance the endogenous driving force of the economy. From the current outlook, we believe that the best policy response is to reduce regulation and unleash entrepreneurial spirit. Meanwhile, the PBOC could take more aggressive actions by fully purchasing RMB-denominated assets, including bonds, land, and residential property.