SHANGHAI (Reuters) - China is preparing to allow pension funds managed by local governments to invest in the stock market for the first time, potentially channelling hundreds of billions of yuan into the country's sagging equity market.

Beijing published draft rules on the proposed change late on Monday, hours after China's stock markets had closed sharply despite surprise monetary easing moves by the central bank at the weekend.

The pension funds would be able to invest up to 30 per cent of their net assets in China's stocks, equity funds and balanced funds, according to the draft published by the Ministry of Human Resources and Social Security and Ministry of Finance for public consultation.

They could also invest in bonds, money-market instruments, asset-backed securities, index futures and bond futures in China, as well as the country's major infrastructure projects, according to the rules.

The pension funds can currently only invest in bank deposits and treasuries.

Together the funds have assets of more than 2 trillion yuan ($434 billion) that can be invested, meaning about 600 billion yuan could theoretically go into the stock market, according to the official Securities Times newspaper.

The news rules were aimed at "improving investment returns of the pension funds ... and promoting healthy and sustainable development of China's pension system", the government agencies said.

Local governments are allowed to mandate institutions authorised by the central government to manage the pension funds.

On Sunday, two industry sources with direct knowledge told Reuters that China's cabinet had approved plans for the manager of the country's biggest pension fund to manage pension funds worth about 2 trillion yuan for local authorities.