A woman blows a bubble gum at a stock exchange market in Shanghai May 29, 2007. China has raised stamp tax on securities trading has been raised from 0.1 percent to 0.3 percent beginning Wednesday, May 30, in an effort to cool the overheated stock market. [Reuters]

Chinese stocks Thursday rebounded in volatile trade from the second sharpest fall in a decade that was caused by the tripling of stamp tax on stock trading the day before.

The benchmark Shanghai Composite gained 1.40 percent to close at 4,109.65 points, reversing Wednesday's 6.5 percent plunge. The Shanghai and Shenzhen 300 Index rose 1.07 percent to 3,927.95.

The recovery was largely driven by blue chip stocks as some investors thought these stocks would be better to hold in the long-terms rather than trade in small, speculative stocks.

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Bank stocks staged strong performances, with Pudong Development Bank having the biggest gains, jumping to its daily limit of 10 percent to close at 33.76 yuan per share. Huaxia Bank soared 8.27 percent to 13.09 yuan, followed by China Merchants Bank, which surged 8.22 percent to 21.72 yuan.

The Industrial and Commercial Bank of China rose 3.01 percent to 5.48 yuan, while Bank of China went up 4.56 percent to 5.73 yuan.

Sinopec was also strong. It jumped its 10 percent daily limit to 14.85 yuan after gaining more than two percent on Wednesday.

However, only 343 out of more than 1,400 stocks in the Shanghai and Shenzhen Stock Exchanges posted gains, as investors remained jittery about the government's potential further moves to cool down the market.

On Tuesday night, the Ministry of Finance announced the stamp tax on stock trading would be raised to 0.3 percent to 0.1 percent, prompting the second sharpest fall in a decade. The biggest fall happened on February 27 when the Shanghai Composite Index nosedived nearly nine percent, which was partly blamed for a global sell-off.

The real impact of the duty hike is on the market sentiment, said Tao Dong, chief China economist of Credit Suisse First Boston. "Actually what the market cares now is not the increase in the stamp tax, but the further tightening measures the government might take."

Tao believed the duty increase is just one measure in the government's toolbox to cool down the market. "More measures are likely to follow," he warned.

Deutsche Bank chief China economist Ma Jun echoed Tao's points, but he thought that regulators will take more actions depending on the development of the market in the days, and weeks ahead.

"If the market pulls back 15 to 20 percent, which is what the government would like to see, then maybe there will be no more harsher policies," Ma said. However, if the market ignores the signal and continues to soar, for example, rising 20 percent in a month, then the stamp tax might be further raised, he explained.

There is also speculation that the government will levy a capital gains tax and abolish the interest tax soon, but a State Administration Taxation official rejected that rumor.

"In the short-term, there will be no policy on the levy of capital gains tax or the abolition of interest tax," said the official who was quoted by Beijing News on Thursday.

However, what investors think of what regulators say and what they actually do remains unknown. On May 28, the Ministry of Finance denied the rise of stamp tax, but announced the hike six days later.

Trading was heavy, albeit not as active as the previous session. Turnover in the Shanghai Stock Exchange hit 239.52 billion yuan compared with Wednesday's 271.29 billion yuan. The volume in the Shenzhen bourse topped 121.94 billion yuan against 135.84 billion yuan on Wednesday.