By Geoff Dyer in Shanghai

Chinese stocks fell 5.25 per cent on Thursday as investors continued to fret about the large volume of new share and bond issues that the mainland markets will have to absorb over the next few months.

Mainland share prices have now fallen 12 per cent in the last two weeks at a time when trading volumes have also dropped to levels well below those seen in May.

The share price decline and more modest trading are a further indication that the authorities have managed to take the steam out of the stock market without causing a dramatic correction.

In the first few months of this year, mainland China witnessed an unprecedented fervour for investing in the stock market. Long queues were seen outside brokerage houses in the main cities, as a new generation of investors rushed to put some of their savings into equities.

But in May, although about 300,000 new share trading accounts were being opened each day in China, the average figure over the last two weeks has been just over 100,000. Daily trading volumes for the Shanghai composite index, which includes most of the main listed companies, have fallen from a peak of Rmb257.2bn ($33.8bn) in early May to an average of Rmb82bn so far this week.

Facing a potential bubble in the market, the first reaction of the authorities was to use tax policy to try and damp speculation. In late May, the government tripled the tax on share trading to 0.3 per cent per trade.

The response from investors was near panic. The market fell 15 per cent in four days as investors worried about further tax increases aimed at squeezing them out of the market.

Fearing a collapse in confidence among the new share-buyers, the government appeared to backtrack and state newspapers published prominent editorials about the promising long-term future of the market.

The authorities’ second strategy has been more subtle and apparently more effective. In recent weeks, a series of state-owned companies have come forward with plans to launch large, new share offers in the Shanghai market. Shenhua Energy, a leading coal miner, plans to raise up to $6.3bn through an initial public offering, while PetroChina is looking to do a $6bn listing. China Construction Bank and China Mobile could also come to the market this year.

“It looks as if in July and August, we will see a sharp acceleration of IPOs in the mainland market, which is one reason for the drop in prices in the market,” said Lu Xinwen, strategic analyst of Merchants Securities in Shenzhen.

Such is the long list of companies waiting to sell shares in Shanghai that consultants PwC predicted this week that new listings on the mainland markets would exceed $52bn this year, double the prediction at the start of the year. Liquidity is also likely to be drawn out of the mainland capital markets in other directions. Over the last month, the government has relaxed some of the restrictions on taking capital overseas that will make it easier for domestic mutual funds and brokerages to invest abroad.

As part of the process of setting up a new investment company to diversify the country’s vast foreign exchange reserves, the government said last week that it would issue up to $200bn in bonds to finance the purchase of foreign exchange. That money will be raised in the inter-bank market.

The bond issues were one of the main factors behind Thursday’s sell-off.

“Among investors, the concerns about liquidity in the market have been enhanced by the news of the treasury bills and the likely flows of overseas investment,” said Zhang Yidong, analyst at Industrial Securities in Shanghai.

Yet, in a market in which new retail investors play such a large role, analysts say the authorities cannot afford to be too relaxed about the present situation.

“When a market like this enters a phase of adjustment, we can also see some irrational panic,” said Mr Zhang. “We cannot rule out the possibility that it will fall further in the coming days.”

Copyright Fund China 2008.

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