Hong Kong's Hang Seng Index has lost 25 per cent since its peak in May though the most breathtaking plunges have been on the mainland exchanges. The Shanghai Composite Index has lost 38 per cent since May while the Shanghai Shenzhen CSI 300 Index has shed 37 per cent.

Beijing retains some semblance of control over the sharemarket through a range of measures, from a longer-standing 10 per cent limit on how heavily a stock can drop in a single session to the recent extremes of direct intervention in the equity markets via regulators to prop up prices.

While shareholders have been willing to accept this level of control, foreign investors are increasingly bewildered and unimpressed with the Chinese central authorities after the arrest of almost 200 people including journalists and traders who have been accused of spreading rumours and creating market panic.

The government-run regulatory agencies are also urging listed companies to boost dividends, restructure themselves or merge as well as buy back their shares to create more shareholder value.

But investors and economists are getting more concerned the increasingly heavy-handed government intervention will undermine the whole financial system.

Bank of America-Merrill Lynch head of China equities strategy David Cui is forecasting the markets will continue to fall for some time and warns that escalating, or indeed any, significant government intervention will have broad ramifications.

Inflated markets

"The government cannot sustain the buying because there are terribly negative consequences if they keep buying stocks, including [damaging] the People's Bank of China's credibility, as well as the renminbi's credibility," Mr Cui said.

JPMorgan Chase chairman Jacob Frenkel said the time for China to intervene was over, and markets should prepare for continuing volatility as the Chinese economy underwent its "dramatic transformation" and as Beijing grappled with its financial markets which had become "inflated beyond reason".

"A correction may ultimately enhance the Chinese market's credibility as long as the authorities allow it to proceed and do not disrupt it through artificial means," Mr Frenkel said.

The combination of a momentum-driven market dynamic and high levels of leverage suggested Chinese shares would continue to experience a period of dramatic plunges followed by brief periods of stability after Beijing intervened, only for the market to plummet again once the government withdrew its support, Mr Cui said.

"We're a very long way from when it will reach levels cheap enough for investors to buy shares for fundamental reasons," he said.

Mr Cui said the continuing depreciation of the equity markets and the government trying but failing to pull it back in line could destroy investor confidence, both local and foreign, and have long-term impacts on the stability of the financial system.

"If the government is determined to support the market, there will be a lot of very severe consequences on the renminbi, on the economy and on growth."

The renminbi has lost 3 per cent since the government lowered its midpoint in early August and Nomura China research analysts describe the internal attitude towards the currency as increasingly cautious.

"Our foreign exchange team believes that sentiment on the Chinese yuan is already extremely negative, fast money is already positioned for Chinese yuan depreciation, and that local corporates have been building up US-dollar deposits," Nomura China analyst Wendy Liu said.

Core to Mr Cui's warning is the fact that what underpins a currency is confidence in its central bank as any can simply print unlimited money.

"People hold currency because they have faith in the central bank and believe it won't do anything foolish," Mr Cui said. "So confidence is very important in a currency. Buying very highly overvalued stocks will damage the renminbi's credibility."