HK shares drop to 7-wk low; Shanghai stocks fall

* HK shares fall most in three-weeks to seven-week low

* China shares drop on news of year's largest IPO

* China Eastern, Shanghai Airlines gain on merger news (Updates to close)

By Parvathy Ullatil and Claire Zhang

HONG KONG, July 13 (Reuters) - Hong Kong shares fell the most in three weeks, dropping 2.6 percent to a seven-week low on Monday as worries about likely austerity measures from Beijing, following a strong surge in bank lending in the first half, persisted.

Chinese stocks slipped 1.1 percent, with large caps falling on worries that investors would trim holdings to chase a share listing by China State Construction -- the world's largest share offering so far this year.

China Eastern Airlines (600115.SS) and Shanghai Airlines (600591.SS) jumped by their 5 percent daily limits in Shanghai after China Eastern said it would acquire its smaller rival in a share swap worth 9 billion yuan ($1.3 billion), which would give the newly capitalised airline more than a 50 percent market share in China's financial hub. [ID:nSHA356830]

China Eastern's Hong Kong-listed shares (0670.HK) rose as much as 14.4 percent in early trade to an 11-month high, but the H shares pared gains to finish 2.9 percent higher at HK$1.79.

"The merger is beneficial in the long term as China Eastern's market share will be greatly enlarged. But in the short term, money matters continue to be an overhang," said Linus Yip, strategist with First Shanghai Securities.

"The initial stock reaction seems to have captured most of the positive news in the announcement, so in the short term investors would do well to sell the stock," he said.

FURTHER LOSSES SEEN IN HONG KONG

The benchmark Hang Seng Index .HSI was down 453.63 points at 17,254.63, while turnover languished at HK$52.5 billion.

"Indications from the U.S. suggest the market may have underestimated the extent of the recession and the data that will come out later may be worse than expected," said Peter Lai, director with DBS Vickers.

Lai projected the index to drop below 16,000 points this quarter. The gauge has dropped less than 10 percent from its June peak of 19,161.97 despite a two-week slump.

"There could be other signs this quarter to suggest the revival is not coming along as speedily as people though it was, after all this is a global recession," he said.

The China Enterprises Index .HSCE, which represents top locally listed mainland Chinese stocks, ended down 2.8 percent at 10,279.25.