SHANGHAI, June 26 (Reuters) - Chinese stocks plunged over 7 percent on Friday, with one key index recording its biggest fall since 2008, hit by tight liquidity conditions ahead of the quarter-end and uncertainty over the central bank's easing policy.
The market is now down over 20 percent from seven-year highs hit two weeks ago, with selling accelerated by investors rushing to unwind positions built on borrowed money, but investors are divided over whether the boom has come to a bust.
Jiang Chao, strategist at Haitong Securities, said that based on meetings with fund managers over the past week, he believed that institutions were "collectively at a loss" over the direction of the stock market.
"Many people said they're keen to lock in profit, rather than make profit in the second half, because they have made enough in the first half."
Any crash would have major implications on Beijing's push to open up its financial markets, most imminently a plan to link the Hong Kong exchange with China's smaller Shenzhen bourse.
It could also have implications for the broader economy, given the high level of market participation by retail investors, though Beijing has weapons in its arsenal if it fears too big a knock-on effect.
It has previously used state funds to pick up shares on dips, eased the pace of initial public offerings and used editorials in state media to boost confidence.
"The foundation of the bull market has not materially changed," Bosera Asset Management Co said in an emailed comment on the market tumble.
Zhang Xiaojun, a spokesman for China's securities regulator, told a regular news conference that recent falls in the market were just reversing "excessive gains" after a strong run-up and that the economy was showing clear signs of stabilising despite the fall.
A slew of initial public offerings has also bloated the supply of stocks, which fell across the board on Friday.
About 2,000 of the roughly 2,800 listed companies in Shanghai and Shenzhen slumped by their 10 percent daily limit.
At the close, the key CSI300 index was down 7.9 percent, its biggest one-day percentage fall since June 2008, while the Shanghai Composite Index tumbled 7.4 percent.
Traders said the selling accelerated as it triggered margin calls, which forced investors to bail out of stocks bought on borrowed cash.
"Many of the investors I know bought stocks using margin financing, with little cash left in their accounts," said Zhang Chen, analyst at Shanghai-based hedge fund Hongyi Investment.
"Recent slumps left them with no choice but to sell on margin calls," Zheng said.
A more than doubling of China's stock market over the past year had been underpinned by rapidly expanding margin financing, monetary easing and hopes of economic restructuring, but analysts said two of the three legs are now shaky.
Regulators have been cracking down on illegal margin financing and urging brokerages to tighten rules. Many investors have also faced increasingly expensive margin calls in the past week as share prices have retreated.
Outstanding margin loans shrank for the third straight day on Wednesday to 2.2 trillion yuan ($354 billion), as investors slashed 61.5 billion yuan worth of leverage during the period, the latest data shows.
Haitong's Jiang said further monetary easing, another pillar of investor optimism, is also in question.
"Recent bond market performance reflects institutional investors' view that the rate cut cycle is coming to an end," he said.
Morgan Stanley sees Shanghai's benchmark index falling between 2 and 30 percent from current levels over the next 12 months, citing heavy equity issuance, weak corporate earnings, demanding valuations and excessive levels of margin financing. (Editing by Will Waterman)