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 plummeted nearly seven percent on Wednesday after the Ministry of Finance announced a hike in the stamp tax on stock trading to 0.3 percent from 0.1 percent.

The benchmark Shanghai Composite Index lost 6.50 percent to close at 4,053.09 points after opening 5.78 percent lower. The Shanghai and Shenzhen 300 index fell 6.76 percent to 3,886.46.

More than 1,200 stocks fell on the Shanghai and Shenzhen stock exchanges, with over 800 tumbling to their daily limits of 10 percent. Only 66 stocks rose in the two bourses.

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Trading was heavy, with turnover in the Shanghai Stock Exchange hitting 271.29 billion yuan, while volume reached 135.84 billion yuan in Shenzhen. That means the government raked in 2.44 billion yuan in stamp taxes in a single day.

Shares of brokerages were hardest hit due to concerns the tax would lead to decreased market turnover, which in turn will affect brokerage revenue. CITIC Securities and Hong Yuan Securities both opened the daily limit of 10 percent lower.

That marked the sharpest fall since February 27 when the Shanghai Composite Index nosedived nearly nine percent, which was partly blamed for a global sell-off.

The tumble came after the Ministry of Finance announced Tuesday night the stamp tax on stock trading will rise to 0.3 percent from 0.1 percent starting from Wednesday. It was the authorities' latest move to cool down the country's hot equity market.

A ministry official said the measure is intended to help promote the healthy development of the securities markets.

Analysts said the tax hike could dampen the market in the short term, but would not cause a crash or reverse a long-term upward trend.

Ha Jiming, chief economist of China International Capital Corporation said the hike will increase investors' transaction costs and is expected to curb short-term speculative activities. But the influence on long-term investment is limited.

"The hike will neither reverse the upward trend of the stock market, nor lead to consistent downfalls," he said. Ha added the hike was good news for the long-term healthy development of China's capital market.

The policy will help the market become more rational, he said. However, to return full sobriety to the market, the government needs to come out with more policies.

He Qiang of Central University of Finance and Economics deemed the new policy's influence largely "psychological".

"Currently, the investors' return from the stock market is high," he said. "The stamp tax hike will increase the transaction costs, but is unlikely to bring about a substantial reduction to the high returns."

The fiscal measure came after a series of monetary tools issued by the central bank failed to produce marked results in cooling down the market. The Shanghai Composite Index, the most widely watched indicator of the mainland's stock market has soared more than 60 percent so far this year on top of a 130 percent rally in 2006.

This year, China's central bank has raised interest rates twice and bank reserve requirement four times. However, the stock market ignored these signals and the index rose on the first trading day after each tightening.

The boom is partly driven by the flood of new investors. The number of stock accounts, including A-, B-shares and closed-end funds in the Shanghai and Shenzhen stock exchanges reached 100.27 million on Monday, according to statistics from the China Securities Depository and Clearing Corporation.

The stock market frenzy has aroused concerns that a bubble is mounting, from both home and abroad. The latest warning came from former chairman of the US Federal Reserve Alan Greenspan who warned last week China's stock market was clearly unsustainable and faced a dramatic contraction.

Greenspan's remarks followed comments from Asia's richest man, Li Ka-shing who said China's stock valuations "must be a bubble" and prices are likely to decline. Central Bank governor Zhou Xiaochuan also expressed concerns earlier this month.

Some analysts have been advocating the adoption of fiscal measures, including the hike of the stamp tax, which is calculated based on transaction turnover and is levied on both sellers and buyers.

History of stamp tax

In the 17-year history of China's stock market, a stamp tax hike usually led to a slump in the market.

China started collecting a stamp tax on the Shenzhen Stock Exchange in July, 1990, but only levied on sellers at 0.6 percent. Four months later, buyers were also subjected to the tax.

The tax triggered a downturn in the Shenzhen market, forcing authorities to cut it in half to 0.3 percent in October 1991. At the same time, the Shanghai Stock Exchange also began collecting duty on both sides of trades.

On May 10, 1997, the tax rate was upped to 0.5 percent, which may have caused a bear market that lasted until mid-1999. The rate was lowered to 0.4 percent in June, 1998 before being adjusted to 0.3 percent one year later and then to 0.2 percent in 2001.

Regulators further lowered the duty in January 2005 to 0.1 percent in order to boost stock prices during a market slump lasting from 2001 to 2005.