In an effort to tame the frenzied stock market last year, the China Securities Regulatory Commission (CSRC) implemented a "circuit breaker" mechanism to mitigate the impact of future fluctuations. The mechanism started operating on January 4, but was subsequently responsible for the early end of the first day of trading in 2016.

(Editor's note: China has introduced the "circuit breaker" mechanism to follow the Hushen 300 Index, which reflects the performance of both the Shanghai and Shenzhen stock market. Should the index rise or fall by 5 percent, the "circuit breaker" will trigger a 15-minute suspension in trading. Trading is outright terminated for the day if the Hushen 300's rise or decline is greater than 7 percent. On January 7, the "circuit breaker" mechanism resulted in the shortest day of trading in the Chinese stock market's 25-year history--exchanges lasted just 29 minutes. The CSRC ordered the temporary suspension and review of the mechanism's operations, just four days after its introduction.)

Recent market imbalances have aroused widespread speculation regarding whether or not the mechanism actually fits China's stock market. So, what are the reasons behind the immediate triggering of the "circuit breaker" after its launch?

First of all, there are widening concerns over China's economic outlook. According to statistics from the National Bureau of Statistics and the China Federation of Logistics and Purchasing, the purchasing managers index (PMI) for China's manufacturing industry stood at 49.7 in December 2015. Though it's a slight increase from the previous month, the manufacturing PMI has been below the level of 50 for five consecutive months--a reading over 50 indicates expansion, while anything under 50 expresses contraction. Also, manufacturing activities in the last quarter of 2015 were less robust than that in the third quarter. Even worse, investment and export also fell short of expectations in 2015, implying that the economy faces increasing downward pressure.

Considering this trend, these concerns are valid. The housing industry is currently under pressure to reduce their inventory, especially in third-tier and fourth-tier cities, as part of efforts to avoid a property bubble collapse. The manufacturing sector also has to reduce their inventory. Due to Chinese enterprises' high leverage ratios, investment will continue to be suppressed. In addition, considering the current global economic situation as well as China's underperforming export trade in 2015, this year's exports are likely to fall short of expectations as well. Therefore, it's widely believed that China's economy will grow at a slower pace than that of past several years.

Moreover, panic and paranoia recently spread like a virus among investors due to the U.S. Federal Reserve's (Fed) decision to make reverse repurchase operations on the last day of 2015. The New York Fed on December 31, 2015 awarded a record $474.59 billion of one-day fixed-rate reverse repurchase agreements to 109 bidders at an interest rate of 0.25 percent. This implied that the United States will keep pushing the dollar's interest rate up, and adding fuel to anxieties that capital is bleeding out of China. On the other hand, on the first trading day of 2016, the exchange rate of onshore yuan against the U.S. dollar tumbled 0.62 percent to 6.5338, the weakest level since April 2011, while that of offshore yuan against the dollar slumped 0.85 percent to 6.6256. That's to say, as the effects of the Fed's interest rate hike are made clear, investors are increasingly likely to unload their yuan-denominated assets.

Beyond that, restrictions barring majority shareholders from selling their stocks were removed on January 8. Since many shareholders purchased large quantities of shares when prices plummeted last June, and some mid-and small-cap stocks are now overpriced, the tendency is to cut shareholding after making fat profits.

Another source of anxiety is the prospective implementation of a registration-based initial public offering (IPO) system. The first changes brought by the reform are expected to kick off in March. Given that there is a long line of companies waiting to get listed, investors are worried that after the registration-based IPO system is implemented, new companies will saturate the market. In such a scenario, it is possible that overpriced listed companies will lose value, adding to market pressures.

Finally, deep-rooted problems in China's stock market must be taken into account when analyzing the overall economic situation. The interests of the investors haven't been protected as effectively as they should have been. Some listed companies almost never pay dividends to investors, so stock investors often profit from speculative activities instead. Data from the Ministry of Finance show that stamp duties on securities transactions amounted to 239.5 billion yuan ($36.36 billion) in the first 11 months of 2015. Counting in commissions charged by securities traders, the figure ballooned up to 450 billion yuan ($68.31 billion). In sharp contrast, a total of 219 companies that got listed in the Shanghai and Shenzhen stock markets last year only raised a meager 158.6 billion yuan ($24.08 billion) through their IPOs, according to statistics from Deloitte.

A lack of effective investor protection has also led to frequent insider trading scandals. Revelations of malignant insider trading have played a role in daunting stock investors. Investigations into the activities of high-ranking CSRC officials and many executives from securities companies, as well as media reports of collusion and interest transfer behaviors have, to some extent, shaken investors' confidence in the securities watchdog's ability to monitor and regulate the market.

Though the stock market has started the year on the wrong foot, the situation is not hopeless. Regulators are pushing for reform. As problems continue to arise, the government has shown that they are willing to experiment and be flexible, adopting strategies designed to iron out the wrinkles in the stock market. Meanwhile, the government is also striving to stoke the economy by carrying out reforms to the supply side, producing policies facilitating property destocking, as well as implementing a universal two-child policy. In this sense, China's economic outlook is still promising.

This is an excerpt of an article written by Bian Yongzu, an associate research fellow from Chongyang Institute for Financial Studies at the Renmin University of China, published on China.com.cn. 

Copyedited by Bryan Michael Galvan

Comments to yushujun@bjreview.com