Industrial Securities chief strategist Thomas Zhang did not see the rebound as the start of a new rally, saying the mainland share market would see "one of the worst years in history", with the situation similar to 2005, when the market shed 8.3 per cent.

"The local government debt issue is still a big overhang for both Hong Kong and [mainland] China," Zhang said.

"By the end of the third quarter, we are likely to see some defaults in local government debt in Hubei, Yunnan, Guizhou or Hainan, and the market would be very volatile by then."

The third quarter would be the peak season for local governments to repay some of the money they borrowed to invest in the country's numerous construction projects, some of which were reported to be generating zero or negative returns, he said.

Mainland property developers, banks and insurers led the gains amid an easing of credit on the mainland.

China Resources Land added 6.6 per cent to finish at HK$21.90, after the media reported that the central government might give developers some leeway to seek financing.

Banks and insurers jumped, led by China Minsheng Bank, which was the stock short sold the most on the mainland when the overnight repo rate soared to a record high last month. The stock surged 7 per cent to close at HK$8.15.

Market participants expected the seven-day repo rate, a gauge of interbank liquidity, to ease further as the central government wants to avoid keeping credit too tight following a slew of sluggish economic data.

The rate stood at 3.8 per cent yesterday, compared with 11 per cent on June 20.