Chinese stocks took another battering on Monday, as investors went into panic selling due to rising concerns over domestic inflation and fallout from the United States' credit crisis and possible recession.
Investors fear that the central bank may resort to further monetary tightening, to fight inflation as consumer price index jumped 8.7 percent in February year-on-year, the fastest in nearly 12 years.
There is still room for further rises in interest rates and bank reserve requirements, central bank governor Zhou Xiaochuan said during the weekend.
Rate hikes will increase firms' cost of capital, thus eroding their profitability. Unlike in developed countries, Chinese companies rely heavily on bank loans, instead of direct financing.
Rises in the amount of money that commercial banks must put in the central bank as reserves will also reduce the cash available for investment in the equity market. Zhou's agency has ordered six increases in interest rates and 11 in reserve ratios since the start of 2007.
Growing worries over the fallout from the credit crunch stemmed from the subprime crisis across the Pacific also dented the sentiment.
US financial giant Bear Stearns has been pushed to the brink of collapse by the turmoil and was sold to JP Morgan Chase in an emergency deal. Investors feared the worst of the crisis is yet to come and drag the world’s largest economy deep into recession.
Any downturn in the US economy will reduce demand for Chinese products, thus slightly slowing down China's economy, as well as affecting the profitability of exporters.
A robust Chinese economy and the ever-growing corporate earnings are two key drivers of the recent bull run.
Lingering fears over companies' refinancing plans, and the expiration of the lock-up period for shares worth tens of billions yuan, also added to the selling pressure.
The benchmark Shanghai Composite Index tumbled 3.6 percent to 3,820 points, marking a loss of 30.5 percent in two months. In developed markets, a fall of 20 percent in less than a 12-month period is defined as a bear market.
Monday's fall would have been even steeper without including a 1.25 percent increase in PetroChina, which has biggest weighting in the gauge.
More than 95 percent of the A-shares in the Shanghai and Shenzhen stock exchanges posted losses.