China has halted intervention in the stock market so far this week as policymakers debate the merits of an unprecedented government campaign to prop up share prices, according to people familiar with the situation.
Some officials argue that falling stocks will have a limited impact on the world's second-largest economy and that the costs of supporting the market are too high, said one of the people, who asked not to be identified because the deliberations are private. Officials who back intervention say tumbling shares pose a risk to the banking system, the people said.
The Shanghai Composite Index sank 15 percent over the past two days, extending a $4.5 trillion rout since mid-June that has shaken confidence among equity investors around the world. President Xi Jinping's government is trying to balance a pledge to loosen its grip on markets against the need to maintain financial stability amid projections for the weakest economic expansion since 1990.
"Government intervention has dropped substantially," Michelle Leung, the chief executive officer at Xingtai Capital in Hong Kong, said in e-mailed comments on Tuesday. "The reform- minded camp within the government that favors letting the market do its work seems to be driving decision making right now."
China's November 2013 pledge to let markets play a decisive role in the economy has been put to the test after a record-long boom in the Shanghai Composite went bust. Officials allowed more than 1,400 companies to halt trading at one point last month, banned major shareholders from selling stakes, suspended initial public offerings and gave a government agency access to more than $480 billion of borrowed funds to finance equity purchases.
The China Securities Regulatory Commission didn't immediately respond to a faxed request for comment. On Aug. 14, the CSRC said China Securities Finance Corp., the state agency tasked with supporting share prices, would no longer add to equity holdings unless there's unusual volatility and systemic risk.
China's interventionist response spurred foreign investors to withdraw funds at a record pace last month and prompted the International Monetary Fund to urge Chinese officials to eventually unwind the measures. China is seeking an IMF endorsement of the yuan as a reserve currency, a goal that some analysts have said is being used by reform-minded policy makers to reduce the state's role in markets.
Proponents of the rescue campaign have argued that a buildup of leverage in China's stock market made the financial system vulnerable to a collapse in shares. Margin debt on mainland exchanges climbed to a record 2.3 trillion yuan ($359 billion) in mid-June, before falling to 1.3 trillion yuan this week as the rout prompted traders closed out bets using borrowed money. Margin debt outside official channels may have reached 1.6 trillion yuan in May, according to Credit Suisse Group.
"The government intervention was primarily to unwind the unhealthy levels of margin financing," said Erwin Sanft, the Hong Kong-based head of China strategy at Macquarie Group. "From that perspective, the intervention has been a success."
The Chinese government's current priority is the success of a military parade commemorating end of World War II on Sept. 3 in Beijing, people familiar with the situation said.
More than 90 million individual investors now have stock accounts in China, a constituency that's bigger than the ruling Communist Party. Novice traders piled into the market at a record pace over the past year, encouraged by a series of articles in state-run media that endorsed equity investment.
If the government does stay out of the market, the Shanghai Composite may drop another 12 percent because valuations are still too high, said Wenjie Lu, a strategist at UBS Group in Shanghai. Stocks on mainland bourses traded at a median 61 times reported earnings on Friday, according to data compiled by Bloomberg. That's the most expensive level among the 10 largest markets and more than three times the multiple on the Standard & Poor's 500 Index.
Policymakers should shift their attention to reviving economic growth through fiscal stimulus, which will eventually boost share prices, Lu said.
"The dilemma for the government is that the more stocks they buy, the less likely the market will stabilize itself," he said. "Fiscal stimulus, infrastructure spending and environmental projects are more helpful for corporate earnings. That's not a direct rescue of the stock market, but eventually will be more helpful."