Mainland indices plummet as punters exit from H shares and red chips amid uncertainties over an interest-rate rise With mainland officials giving conflicting signals on the likelihood of an interest-rate rise, investors are increasingly taking the safe route and cutting their exposure to China-related stocks. The H-share index fell 10.54 per cent this week while the red-chip index, which tracks state-backed mainland firms incorporated in Hong Kong, dropped 6.71 per cent. 'The situation in China is very unclear at the moment and the market is very volatile, which is something hedge funds don't like,' said Kingston Lee, the head of Hong Kong and China research at ING Financial Markets. H shares had become 'a very risky asset class' and many fund managers were reducing their holdings, he added. Foreign investors are not the only ones selling China plays. In the domestic market, the Shanghai A-Share Index has fallen 3.23 per cent in the past two days as economic data added to speculation that a rate rise may be inevitable even though central bank officials continue to play down the risk, saying previous credit-controls are working. Zhao Xiaoyun, a broker at Guotai Junan Securities in Shanghai, said growing worries on whether Beijing would raise interest rates had depressed buying sentiment in the A-share markets. 'What the markets dislike most is uncertainty,' Ms Zhao said. She said speculation about an imminent launch of the mainland's qualified domestic institutional investor scheme had also clouded the outlook. 'There's a substantial difference in valuation between the H shares and the A shares,' she said. The broad-based setback for the local market over the past five days, which also saw the Hang Seng Index lose 4.36 per cent, has come on the back of a strong rebound from the May 17 lows and some analysts said a correction was not unwarranted. Still, the extent of this week's falls took some market observers by surprise, especially as it coincided with easing concerns about the pace of interest-rate rises in the United States. The consensus is now for a 25-basis-point rise at the end of this month after Federal Reserve chairman Alan Greenspan said the pace of inflation would allow the central bank to tighten monetary policy at a 'measured' pace. Strong labour market data had earlier prompted speculation of a 50-point move. Many investors have opted to await the definitive outcome of the June 29-30 Fed policy meeting, which has led to a global tightening of liquidity. In Hong Kong, some money targeted for the market might have been absorbed by a wave of initial public offerings, dealers said. Oil prices have also returned as a negative factor for the local market after several bombings disrupted Iraqi oil exports, sending crude futures higher in New York towards the end of the week. The bombings also sparked renewed concerns about terrorist attacks, which helped to cap gains on Wall Street. 'A higher oil price is clearly negative for markets and if it stays high for long, then it will start to impact earnings,' said Stephen Corry, a strategist with Merrill Lynch. More important though, he said, was that a number of leading cyclical indicators appeared to have peaked, suggesting slower growth going forward. 'We are starting to see signs of downward revisions to earnings forecasts as companies are facing higher input costs, reduced pricing power and slower top-line growth,' he said, noting that Merrill had cut its forecast of 2005 earnings growth for Hong Kong to 1.3 per cent from 9 per cent in April, and had lowered its projection for the mainland to 2.4 per cent from 2.5 per cent. The uncertainty about China and the lack of appetite for risk among asset managers worrying about their funds' performance this year has led to a projection by Mr Lee that the Hong Kong market, H shares included, will 'make new lows before it goes higher'. This suggested the Hang Seng Index would drop 10 per cent from here, he said.