* MSCI inclusion bets, China products demand push indexes higher
* Flash crash in index futures leave broader markets unhurt
* Yuan posts second biggest monthly decline on record (Recasts, adds details)
By Samuel Shen and Saikat Chatterjee
SHANGHAI/HONG KONG, May 31 (Reuters) - Chinese shares posted their biggest daily gain in three months on Tuesday on growing expectations U.S. market index provider MSCI could add mainland stocks to its emerging market benchmark for the first time.
The CSI300 index of the largest listed companies in Shanghai and Shenzhen rose 3.4 percent to 3,169.56, while the Shanghai Composite Index gained 3.3 percent, to 2,916.62 points. The CSI300 ended May around 0.4 percent higher while the Shanghai stock index is around 0.7 percent lower.
Despite Tuesday's bounce, Chinese stocks are the worst performing in Asia so far this year with the Shanghai stock market down about 20 percent, according to Thomson Reuters data.
In the currency market, the yuan posted its second largest monthly fall on record against the dollar in May amid growing expectations of a U.S. interest rate hike as soon as June.
Growing expectations that MSCI will add mainland shares to its emerging markets index for the first time boosted sentiment in Hong Kong and China.
"Investors are now betting China shares will be included into the MSCI Emerging Market index," said Wu Kan, head of equity trading at investment firm Shanshan Finance.
Goldman Sachs increased the chances that MSCI would include mainland Chinese shares in its indexes to 70 percent, citing recent steps taken by to remove obstacles for global money managers to invest in the country's equity markets.
The U.S. bank joins a growing list of investors and brokers who have given Beijing a thumbs up in recent weeks ahead of the MSCI's decision on June 14.
The expectations drove inflows with the CSOP FTSE China A 50 ETF - the largest offshore exchange-traded fund enabling direct foreign investment to Chinese shares - posting a net capital inflow of about 2 billion yuan ($303.9 million) on Monday, the largest single-day inflow in the past year.
The enthusiasm spread to Hong Kong where shares closed at their highest level in more than four weeks. The Hang Seng Index rose to 20,815.09 points, while the China Enterprises Index of mainland stocks listed in Hong Kong gained 0.93 percent to 8,704.90.
Despite the broader market rise, a "flash crash" in the actively traded CSI 300 futures contract earlier in the session dominated trader talk throughout the session and highlighted wider liquidity concerns in China's markets.
The June futures contracts on China's blue-chip CSI300 index plunged the 10 percent daily limit at 10:42 local time, but recovered all its losses within that minute in high volume.
The China Financial Futures Exchanges didn't answer calls seeking comment on the brief crash. The official Securities Times reported on its website that the exchange is investigating the matter and would release results later.
Patrick Ng, founding partner of Shanghai-based PROG Trading Group, said the crash was likely a stampede triggered by automated program trading. About 20 minutes before the slump, his trading system indicated an unusually high chance of profiting by shorting index futures.
"It was likely the result of programmer traders suddenly heading in the same direction," Ng said.
However, Wang Feng, CEO and founder of hedge fund firm Alpha Squared Capital Co, said the event was more likely the result of fat-fingers.
"It must be a trading error. Someone will be punished," he said.
Wang added that the incident also underscored the fact that there is not much liquidity in the futures market after China imposed trading restrictions, making the contract prices vulnerable to a relatively small number of erratic trades. (Additional reporting by the Shanghai Newsroom and Michelle Chen in Hong Kong; Editing by Sam Holmes)