China, HK shares headed for rocky end to gloomy Aug

* China shares headed for 21 pct drop in August

* HK shares set for first monthly drop in six months

* A-H share premium gap at lowest since Jan 2009

* Chine Merchants Bank shrs drop on new fund-raising target

(Updates to midday)

By Parvathy Ullatil & Claire Zhang

HONG KONG/SHANGHAI, Aug 31 (Reuters) - China shares sank 5.4
percent by midday on Monday, with the index heading for its
biggest monthly loss in 10 months, after corporate earnings
failed to keep up with stock price gains and new share issues
were poised to saturate the market.

Hong Kong stocks followed suit, giving up 1.9 percent as it
heads for its first monthly loss since March.

China Merchants Bank (3968.HK) skidded 3.6 percent to
HK$16.82 after the country's sixth-largest lender raised its
maximum fund-raising target for a planned rights issue by 22
percent to 18 billion-22 billion yuan ($2.6-3.2 billion), due to
a likely tightening of banks' capital adequacy rules.

Its Shanghai stock (600036.SS) gave up 4.9 percent.

China's banking regulator issued draft rules this month that
would bar banks from using subordinated and hybrid bonds sold to
other lenders as part of their capital base, as the government
reins in rapid lending growth amid fears that the surge could
fuel asset bubbles and cause a sharp increase in bad loans.

The stock was the worst performer among Chinese banks on
Monday after the lender announced a 37.6 percent slide in its
first-half profit on account of a sharp contraction in its net
interest margins and a rise in its credit cost during the
period.

A-H PREMIUM GAP AT LOWEST SINCE JAN

By 0425 GMT the benchmark Hang Seng Index .HSI 374.69
lower at 19,723.93.

The gauge is set to drop 4 percent in August, paring its
yearly gain to 37 percent while the premium gap .HSCAHPI
between yuan-denominated A-shares and their Hong Kong-listed
counterparts dropped to a 17 percent gain, its lowest since
January this year.

Analysts predict a volatile September for the markets with
the main index loosely supported at 19,462 points, its 50-day
moving average.

"There is still the hope that the Chinese market will
stabilise before Oct 1, the mainland's 60th anniversary. But if
the Hang Seng doesn't claw its way back above 20,000 points in
the next day or two then there is less chance of stability in
the rest of the month," said Linus Yip, strategist with First
Shanghai Securities.

The China Enterprises Index .HSCE, which represents top
locally listed mainland Chinese stocks, was down 1.9 percent at
11,214.06.

China Southern Airlines (1055.HK) tanked 4.3 percent to
HK$2.43 after it said its net profit fell 97 percent in the
first half of 2009, reflecting the impact of the outbreak of
Influenza A H1N1 and intensified market competition, in addition
to the global economic slowdown.

BYD Co (1211.HK) bucked the downtrend to rise 3.3 percent
after its first-half profit rose 98 percent, reflecting expanded
market share for its handset components and assembly businesses
despite a shrinking handset industry. Its automobile
business also achieved solid growth, with turnover surging 133
percent.

BIGGEST MONTHLY DROP SINCE OCT 08

The Shanghai Composite Index .SSEC ended the morning at
2,706.960 points, putting it on track to post a 21 percent loss
for the month after recording seven consecutive monthly gains.
It is down 22 percent from this year's high.

Losing Shanghai A shares outnumbered gainers by 894 to 45
while turnover for Shanghai A shares dropped to 70.2 billion
yuan from Friday morning's 73.3 billion yuan.

Oil refiners were hit hard for a third day as
state-regulated domestic fuel prices remained unchanged despite
surging global crude oil prices, disappointing market
expectations of a fuel price hike.

Shanghai-listed A shares of top refiner Sinopec Corp
(600028.SS) slid 9.5 percent at 11.20 yuan by midday.

Analysts saw no fresh news on Monday morning to trigger the
slide but noted lingering pressure from a multitude of factors,
including worries about declining liquidity in the market, too
many new shares flowing in and weakening investor sentiment.

The index sagged below its 125-day moving average, now at
2,755 points, which is viewed by most Chinese investors and
analysts as a watershed between a bear and a bull market. It was
the first break through the closely watched chart line since
early February.

"Shorts and longs may still fight for control of tha
(125-day moving average) level in coming days, but the market
will in any event remain sluggish in the first half of September
as investors await August economic data," said senior stock
analyst Qian Xiangjing at CITIC-Kington Securities in Hangzhou.

A convincing breach of the key moving average, which
analysts said still requires a few days to confirm, would put
the index's next support at 2,500, a more psychological level
than technical one.

That would suggest a market more driven by investor
sentiment than fundamentals.

Analysts said slowing lending should have no major impact on
the economy, partly because Chinese companies are turning much
of the short-term discounted bill financing they received in the
first half-year into long-term investment in the second half.

Metallurgical Corp of China's Shanghai A-share initial
public offering, which aims to raise about 16.85 billion yuan
($2.47 billion), will start book-building on Tuesday and take
subscriptions next week. [ID:nSHA362276].

China's Baosteel (600019.SS), the world's third-largest
steelmaker, plungd 7.1 percent to 6.41 yuan after saying its
first-half net profit dropped 93 percent. [ID:nSHA368837]

(Editing by Edmund Klamann and Ken Wills)