China's stocks enter bear market

Chinese stocks have fallen to a four-and-a-half-year low amid continued concern over the government's credit-tightening policy.

The Shanghai Composite SSE index fell 5.3% to 1,859 points. This resulted in shares entering bear market territory - describing a 20% fall from a recent peak.

China's Central Bank has indicated that its credit-tightening policy will continue, saying the era of cheap credit is over. A government-led credit boom has been one of the key contributors to China's economic growth in recent years. This is the first time since January 2009 that the Shanghai Composite index has fallen below the 1,900 point mark. It has dipped 24% since its high of 2,444.80 points in February.

After the global financial crisis in 2008-09, China unleashed a huge monetary stimulus to boost economic growth.

While the credit boom helped cushion the impact of the crisis on its economy, it led to concern that too much cheap cash had flooded its financial system.

There have been calls for China to contain this credit boom and also to reduce its reliance on credit and investment-led growth. Recently the People's Bank of China (PBOC), the country's Central Bank, temporarily turned off the flow of cheap money to impose more discipline on its banks and reduce their reliance on credit.

That resulted in China's banks, mostly state-owned, charging each other some of the highest lending rates ever, over 25% in some cases, triggering fears of a credit crunch.

There were fears that the money markets could freeze up completely and put smaller lenders out of business as a result of the Central Bank's drastic move.

But inter-bank lending rates eased last Monday as PBOC made it clear big commercial banks should do a better job of managing their cash reserves and keep lending to smaller players.

However, the Central Bank did not signal it was turning the taps back on, leading traders to speculate that borrowing costs would remain relatively high for medium-sized banks and potentially dent profits.

BBC chief business correspondent Linda Yueh said the PBOC's move means that "banks can't count on the Central Bank for cheap cash".

"In fact, the Central Bank wants to root out the poorly-performing banks - especially those in the so-called shadow banking system."

China, the world's second-largest economy, has been one of the biggest drivers of global growth in recent years. Its economic rise has seen it become a key trading partner of the other Asian economies, becoming a major market for exports from those countries.

China's shadow banks, unregulated and with little risk management, are a ticking time bomb, said Rajiv Biswas from IHS Global Insight. It buys a variety of products, ranging from commodities such as iron ore and coal from Australia and Indonesia to consumer goods from Japan and South Korea.

Analysts and investors have been concerned that if growth in China slows sharply, it will affect growth in the region's economies that rely on Chinese demand.

As a result, regional markets have been nervous about the developments in China.

Japan's Nikkei 225 index dipped 0.7%, South Korea's Kospi index shed 1% and Australia's ASX 200 index was down by 0.3%.

Leading miners Rio Tinto and BHP Billiton, which rely heavily on demand from China, were down by more 2.7% and 1.6% on the Australian Securities Exchange.

Analysts said that if fears over China continued to grow, it may hurt mining shares further.

"The actions from the Chinese government to reduce liquidity in China will have on-flowing effects to other firms as well," said a global analyst at Rivkin, Tim Radford. "It's a rippling effect and that's obviously impacted risk appetite in the Aussie market out of fears something could go wrong in China."

BBC