Chinese stocks plunged on Tuesday as the yuan weakened against the dollar, reigniting fears that Beijing may be intent on a deeper devaluation of the currency despite the central bank's comments that it sees no reason for a further slide.
Concerns that companies may pull more money out of China as the economy slows and speculation that the government may begin to scale back its massive support for the country's stock markets also prompted investors to take profits after a run-up in prices over the last few weeks, traders said.
The Shanghai Composite Index closed down 6.1 percent at 3,749.12 points in its biggest daily decline since July 27, snapping a three-day winning streak.
The CSI300 index of the largest listed companies in Shanghai and Shenzhen fell 6.2 per cent at 3,825.41.
Volatility in both indexes spiked in the afternoon in what is becoming a mysteriously recurring pattern in China's stock markets since Beijing stepped in to avert a full-blown price crash in early summer.
The yuan fell against the dollar on Tuesday despite a slightly stronger midpoint set by the central bank, and traders expect the currency to remain under downward pressure as the economy struggles.
The People's Bank of China devalued the currency last week by nearly 2 per cent, triggering an avalanche of selling by investors who feared Beijing wanted to engineer a much sharper decline to support weak exports. The PBOC was later forced to step into the market and tell state banks to support the currency.
Shares of importers and firms with high U.S. dollar-denominated debt have been under pressure along with Chinese airlines which face higher fuel bills following the devaluation.
The central bank made its biggest injection of funds into money markets in more than six months early on Tuesday, adding to worries that liquidity was tightening as investors moved more capital out of the country.
Minsheng Securities estimated 800 billion yuan ($125 billion) had flowed out in July and August alone.
Investors have also grown more concerned that Beijing may begin to withdraw its unprecedented support for share prices.
China's securities regulator said last Friday that the government will allow market forces to play a bigger role in determining stock prices, the first official signal from Beijing that it could be moderating its efforts to prop up its equity markets via state-backed financial institutions.
"The CSRC made it clear last week that the state will withdraw from regular market intervention to support share prices," said a senior trader at a major Chinese brokerage in Shanghai.
"Because sentiment has been weak since the sharp fall that began in June, people believe the market itself cannot support current share price levels without the state's support."
Selling was broad based. The CSI 300 infrastructure index fell 8.4 per cent, the energy index dropped 6.1 per cent, and the real estate index tumbled 7.3 per cent despite data which showed Chinese home prices rose for the third month in a row in July. ($1 = 6.4016 Chinese yuan)
