Private investors in China own 80% of China's shares

The benchmark Shanghai Composite Index lost 139.8 points to 4,091.45.

Chinese shares have hit record levels in recent months as investors have pumped money into the market, raising fears that equities are overvalued.

The government has been trying to cool demand and bring valuations to more realistic levels, analysts said.

One potential drag on the upward momentum of the Chinese market could be the effects of a surge of new shares coming onto the domestic market in the second half of the year.

"Liquidity pressure might be a problem," said Cao Yan, an analyst at Soochow Securities.

Investors have become very nervous about policies again Chen Jinren, Huatai Securities

The falls in the Shanghai Composite Index depressed sentiment in markets worldwide, with Britain's top index FTSE 100 trading 0.4% lower and the German and French markets both down.

But the effects were muted compared to the global share slump after Chinese shares fell almost 9% in February.

Strain

Petrochina and China Construction Bank were two of the largest firms that announced plans on Friday to bring more shares onto the Shanghai Composite Index.

In addition, it is expected that one of China's largest commercial banks, the Bank of Beijing, will seek to list in Shanghai and in Hong Kong before the end of the year.

Some observers said that despite the dip in share prices, the increased supply of tradeable stock would improve corporate governance and should, in the long run, benefit the market.

But others noted that the losses could signal further measures by Beijing to curb the country's booming economic growth and therefore the exuberant domestic market, which quadrupled in value in 2006 and is so far up almost 60% this year.

The government suddenly tripled stamp duty on share trading at the end of May, which sent the stock market reeling, though these losses were since recovered.

'Very nervous'

This week, China said it would reduce or remove tax breaks for thousands of exported goods from July 1 to help control the soaring trade surplus, which rose 73% in May to to $22.5bn (�11.4bn) and ease tensions with its main trading partners, including the US.

Also this week, Chinese institutional investors were given the green light to invest in shares listed in Hong Kong, broadening the scope of investors to trade in markets abroad and diluting the prospects for domestic shares.

"Investors have become very nervous about policies again," said analyst Chen Jinren at Huatai Securities.