Small-cap stocks pulled Chinese equity markets sharply lower again on Tuesday as the country’s equity bubble continued to deflate amid worsening economic data and tighter liquidity.

The Shenzhen Composite, an index that includes shares of many of China’s young technology and healthcare companies, dropped 5 per cent following Monday’s 6.7 per cent slide. The ChiNext startup board tumbled 5.7 per cent.

The Shanghai Composite fell 3.5 per cent, deepening Monday’s 2.7 per cent drop.

The ChiNext, often seen by analysts as the embodiment of the stock market fever that gripped Chinese retail investors for much of the past year, has dropped almost 13 per cent in the past two days alone. Having hit a peak just below 4,000 points in early June, the index closed on Tuesday at 1,797 points — its lowest since February.

Chinese stocks listed in Hong Kong fared better, with the Hang Seng China Enterprises index slipping 0.3 per cent.

Analysts pointed to a fresh attempt to clean up risky grey-market lending to retail investors. The China Securities Regulatory Commission, the market regulator, has been tightening the screws again this week on margin finance — the use of borrowed money to buy shares.

An explosion in margin lending was a key driver of the stock market rally in China that ran from summer 2014 until June this year. The CSRC has repeatedly tried to reduce the use of margin finance since the start of the year, only to ease restrictions again if the market responded with a sharp fall.

“Investors are feeling the influence of the grey-market margin financing cleanup, but the more important factor is psychology and fear. Structurally, nothing changed, but there is downward inertia,” said Yang Hai at Kaiyuan Securities in Xi’an.

Others said the market had been hit by rising demand within China for US dollars in the run up to this week’s interest rate decision by the Federal Reserve, and as expectations of further renminbi depreciation have become more entrenched since the People’s Bank of China devalued the currency on August 11. Domestic demand for dollars has, in turn, leached liquidity away from the stock market.

“A set of bad economic numbers, especially weak investment, have not helped. The market appears disenchanted,” said Hao Hong, strategist at Bocom International.

Beijing has taken a broad range of steps over the past couple of months to halt sliding shares, including a ban on short selling, direct share purchases by state entities and a freeze on initial public offerings. The central bank has also cut interest rates and reserve requirement ratios for commercial lenders in order to grease the wheels.

Nevertheless both the Shanghai and Shenzhen markets have continued to suffer from heavy selling pressure and steep declines in trading volumes.

Earlier this month, Zhou Xiaochuan, governor of the People’s Bank of China, said the correction in China’s stock market was “mostly over”. That has given hope to some who believe the painful sell-off, now into its third month, has almost run its course.

“I think the market bottom is in sight”, added Mr Yang. “Actually, from the perspective of both the economy and valuations, it’s not that bad.”

However, many analysts believe the market has further to fall as retail investors continue to unwind leveraged positions built up during the rally.

Additional reporting by Gabriel Wildau in Shanghai

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