China's stock market has been on a continuous downward trend of late, and the latest slowdown has caused panic among brokers. When discussing the problems inherent in China's stock market, many people focus on which internal factors may have caused the slowdown of the domestic stock market, such as bad policies and negative factors.

Some believe that we must look to external factors for the answer. Such factors include the slowdown of domestic economic growth, the escalation of the eurozone crisis, the slowdown of the US economic recovery and the gloomy outlook for BRICS nations. We can see, then, that if external factors are the cause, an external real economy might spend between five and seven years in the doldrums. Therefore, if the domestic stock market has a close connection with the real economy, it would necessarily take time for it to recover from its woes. Yet the US stock market rapidly returned to pre-crisis levels after the 2008 financial crisis erupted.

Others feel that inadequate reforms of the stock market have resulted in a lack of protection for small investors. This year has seen the implementation of a series of significant reforms of the domestic stock market, and these reforms have, to some extent, been successful in addressing problems related to the pricing mechanism, delisting system and the operation of the domestic stock market. Despite this, however, the market has yet to recover, which has led to a loss of faith among small investors, many of whom have either cooled their interest in equities or simply avoided them altogether. In addition, funds companies have seen investors make large withdrawals.

There are two pertinent questions here: Why do investors have so little confidence in the domestic stock market, and what exactly is wrong with China's stock market? It is my belief that the key issue lies in the precise purpose of establishing the market, which directly determines both its operation mechanism as well as interests relations in the market. Ensuring that a stock market has a distinct purpose may lead to specific development, despite the fact that it has the same external form as other markets.

Financial trading is credit trading, which involves speculating on the credit worthiness and financial worth of a given entity. This type of trading allows the investor to hedge company risk on the back of another investment. Due to the nature of trading, both sides of each transaction undertaken can be completely unknown to each other, and as a result of the features of stock prices, stock market transactions can easily fall prey to acts such as speculating and cheating.

Investors are more vulnerable in illegal acts undertaken in the trading of stocks and the impact of these acts is more profound than in any other form of financial trading.

However, China's stock market acts in the interests of state-owned business in order to get them out of trouble via financing, meaning that the government basically controls the domestic stock market. In this case, domestic stock policies will determine which companies meet the criteria to go public and what its listing price will be. Thus, companies' development and stock index will depend on the stock market policies which are formulated and implemented by the government. As a result, the stock market becomes a place where listed companies can earn vast sums of money, where fortunes can be made by insider trading, and where China's elite can use public money to tighten their grip on power and further increase their profits.

Since the Chinese government holds the reigns of the stock market, it has to guarantee the market implicitly. Consequently, the interests of listed state-owned companies are closely connected with political power. Indeed, the closer the relationship between state-owned companies and the government, the more these companies will thrive on the stock market. This has been well documented in cases where we have seen big shareholders of listed state-owned companies reap large profits despite the fact that the domestic stock index keeps falling.

In such a scenario, neither credit nor legal systems can be established, since the government has complete control of the stock market. As a result, listed companies are driven to make high-risk investments without real credit and the protection of law because they can reap unlimited rewards by shifting the element of high risk onto others, and eventually, society as a whole. We can see, therefore, why so little progress has been made in reforming the domestic stock market, despite the fact that we have seen some technical improvements introduced into the mechanism.

Overall, though, it is important that we look anew at Chinese institutions with a view to putting proposals for reform into the public domain and out of the solely political arena. Without taking this step, it will be impossible to ensure that the domestic stock market develops in a healthy and sustainable fashion.

The author is a researcher with the Institute of Finance and Banking of the Chinese Academy of Social Sciences.

(The article was first published in Chinese and translated by Gong Yingchun.)

Opinion articles reflected the views of their authors, not necessarily those of China.org.cn.

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