The Chinese stock market was jolted out of its prolonged doldrums on Tuesday by signs that the central government is moving to clean up the mess created by trillions of yuan of entangled local government debt.

The Shanghai Composite Index rose by 1.6 percent to close at 3,502.85, the highest level since May 2008, with airline, railway and infrastructure construction companies leading the rally.

Turnover increased to 601.5 billion yuan ($97.5 billion) from 479.4 billion yuan on Monday.

Hong Hao, [Hong Kong Company Registration Guide]chief China strategist at BOCOM International Holdings in Hong Kong, said, "The central government's proposed plan to swap 1 trillion yuan of local government debt is injecting confidence into the market."

Hong described Tuesday's market performance as "nothing short of a breakthrough", saying it showed that investors are buying into the central government's plan.

The Shanghai Composite Index has risen by 73 percent in the past 12 months, recovering from a prolonged slump that wiped out more value than on any other equity market worldwide.

Most investors are optimistic about the market in the near-term, analysts said. In a report on Tuesday, Huatai Securities predicted that the index will rise to the 4,000 level before meeting resistance.

Mainland investors opened 662,000 new stock accounts in the week ended March 6, the most since December, when the Shanghai gauge jumped by 21 percent.

The outstanding value of margin trading - shares bought with borrowed money - on the Shanghai Stock Exchange rose to a record 880.6 billion yuan on March 13.

Foreign investors have bought mainland shares worth 116 billion yuan through the Shanghai-Hong Kong stock link since the program began in November, according to Bloomberg data.

Among the blue chips, China Railway Construction Corp and China Railway Group gained at least 5 percent after China Economic Weekly reported that the government is considering a merger of the two State-owned giants.

Air China Ltd and China Southern Airlines Co rallied to the 10 percent daily limit, based on speculation that further fuel price falls will boost their earnings.

Hong Kong's Hang Seng China Enterprises Index rose by 0.2 percent, while the Hang Seng Index fell by 0.2 percent.

Stock analysts in Hong Kong agreed that the focus is on the mainland market, which has climbed to levels last seen before the global financial crisis.

The market has extended its world-beating rally since late last year as investors bet that monetary stimulus will revive an economy beset by four years of slowing growth.

"We still see significant upside," [Businesses Registration]Jonathan Garner, head of Asia and emerging-markets strategy at Morgan Stanley in Hong Kong, was quoted by Bloomberg as saying.

He said the Shanghai Composite Index could rise to as high as 5,100 this year.