CAPITAL Asia has formed a $35 million joint venture with two mainland partners to produce, package, market and distribute bottled distilled water through Shanghai Yanzhong Drinks, the only such firm in the city. The venture is 60 per cent owned by Capital Asia, 25 per cent by Shanghai-listed Shanghai Yanzhong Industrial, and 15 per cent by Jian Bang Number Two Industrial Corp of Jiading. ''Demand for distilled water should be great in China, and particularly in Shanghai, where tap water is polluted,'' said Capital Asia director Kelvin Hui Yat-on. ''The increasing business activity in Shanghai has been boosting consumption, and demand for distilled water is expected to continue to rise.'' It is the first time Capital Asia, formerly known as Wai Yick, has tackled manufacturing. It has leased a 10,000-square-metre site for 20 years for one million yuan (about HK$1.33 million). However, the project will use only one third of the area, with the remainder earmarked for expansion, perhaps to produce other drinks. Construction of a 3,300-square-metre factory started in November. Production, expected to begin in mid-1993, is projected at 6,000 tonnes in the first year, 18,000 in the second and 30,000 in the third. The company would sell to other Chinese cities if the Shanghai market proved successful, Mr Hui said. ''Competition is sure to exist. But we think our low costs will enable us to set a more competitive price than imported distilled water,'' he said. He expected the joint venture to recover the investment in three years.