'The regulators are worried because speculative investment is certainly one bogey behind the overvalued shares,' said Jerry Lou, Morgan Stanley's mainland equity strategist. 'It's obvious that the government is trying to avoid a hard landing.'

The Shanghai Composite Index fell 97.883 points or 1.74 per cent to 5,536.569 yesterday. Since last Thursday, the benchmark index has lost 418.196 points or 7.02 per cent.

The State-owned Assets Supervision and Administration Commission (Sasac) published a circular yesterday requiring major government-controlled companies to state clearly the amount of cash they had slated for equity investment in their budgets, an apparent attempt to reduce the risk of state assets evaporating.

Analysts said the move was aimed at curbing speculation in the market and was expected to push billions of yuan out of stocks.

'Sasac hopes to closely monitor the financial conditions of the major government-owned companies,' the watchdog said.

Funds from state-owned companies have been one of the driving forces for this year's stock-market rally. Corporate investors ploughing their cash into the market have reaped handsome returns that have improved their bottom lines.

China Life Insurance, the world's largest insurer by market value, had shares worth 42.6 billion yuan in 17 mainland-listed companies as of June 30, said Wind Information, a Shanghai financial data provider.

'Sasac's requirement will cut corporate investment in the market,' said Feng Yuming, a strategist at Orient Securities. 'It is sending a message to at least the major government-controlled firms that stocks are risky [investments].'

A consensus forecast among analysts is that the new policy will block tens of billions of yuan from flowing into the stock market.

Investors were also spooked yesterday by news that the National Social Security Fund had cut its stock holdings in property, petrochemical and mining between July and September.

A China Securities Journal research report showed that the national pension fund, which is cautious on stock investment, held shares in only 137 companies at the end of the third quarter, down from 172 in the second quarter.

The total volume of shares held dropped to 29.43 billion yuan on September 30 from 33 billion yuan three months earlier.

The decline coincided with market rumours that the central government had urged the pension fund to cut its holdings after the Shanghai Composite Index had more than doubled this year.

The pension fund is holding shares mainly in three industries - machinery, electricity and gas, and metals.

Stephen Green, a senior economist at Standard Chartered Bank in Shanghai, said: 'There is lots of liquidity and there is upward pressure but when the decline happens, it will be very severe.'

A spokeswoman at the national pension fund refused to comment on whether it had dumped shares.

Still overshadowing trading was the prospect of central government steps to cap price gains following Mr Wen's remarks that the government would resort to market forces to squeeze the bubble, although he conceded it would be an uphill task.

In a rare move, Mr Wen, who seldom talks about the securities industry, said: 'The central government understands the importance of avoiding asset bubbles and market turbulence ... We must safeguard both the companies' and investors' interests.'

Analysts said Mr Wen was telling mainland stock investors that the government would help stabilise the overheated market and quell fears the bubble would burst.

'The market has run out of steam now,' said Haitong Securities analyst Zhang Qi. 'It won't regain strength until the bubble is squeezed out.'

Shanghai-listed firms traded at an average of 60 times their forecast earnings yesterday.

In contrast, price-earnings multiples on overseas markets normally stand above 10.