The Shanghai gauge has slumped by nearly 30 percent, or 1,500 points, since mid-June, wiping out about $2.8 trillion in market value. The average loss of individual stock accounts has been around 420,000 yuan, according to media estimates.
"If the government does not step in at this point, the panic sentiment will continue to spread and the stock plunge will deepen," said Lu Ting, chief economist at Huatai Securities.
"It will risk a spillover to the banking sector, as many funds that flew intothe stock market are from trust products sold by the banks."
Lu said the government should create a national financial stabilization fund without an upper limit to invest in large-cap blue chips to boost the weak market. He also called for collaborative regulation among the securities, banking, insurance and monetary regulators to prevent similar crises from happening in the future.
Some analysts warned that the market slump could hold back the country's push for further financial reform and the liberalization of its capital markets.
"The irrational ups and downs show that the Chinese market still lacks an effective market mechanism," said Jay Luo, president of fund management company Dymon Asia Capital.
He said the country should not letthe stock market turmoil derail its efforts to introduce market-driven financial reforms, including switching from an approval-based to a registration-based IPO system.
The A-share market had witnessed a wild rally of 150 percent in the past year until June 12, propelled by highly leveraged margin trading that allows investors to borrow money to purchase stocks. Valuations of some listed startup companies reached as high as 150 times at the peak, similar to valuations seen in the Nasdaq market before the dot-com crash of 2000.
The regulator's crackdown on illegalleveraged trading in May triggered a massive deleveraging that led to a steep fall in stock prices and the forced clearing of stock accounts that failed to meet the margin call.
Xu Hongcai, an economist at the China Center for International Economic Exchanges, said Beijing's determination to deal with the situation will help to stabilize the market, but an immediate rebound is unlikely.
"The market will trade in a volatile band between 3,500 to 4,500 points. A buying opportunity is emerging in cheap, large-cap blue chips now, but the small stocks with excessive valuations will continue to decline," he said.
