Some of its biggest "red chip" companies are now facing financial ruin and foreign banks are refusing to offer new loans.

One of China's largest investment trusts, the Guangdong International Trust and Investment Corp, (GITIC) has gone bankrupt.

China International Trust & Investment Corp (CITIC) has had to be rescued by a $4.5bn cash injection from the Chinese government.

These companies were among the main vehicles by which foreign capital was able to invest in China.

Their collapse shows that China is not immune to the Asian contagion.

According to Charles Tan of the investment rating service Moody's, China shares many of the structural problems that have brought down South Korea, Thailand, Indonesia, and Malaysia.

"These include a weak financial system, excessive lending, deficient central bank regulation, a highly leveraged corporate sector, and incompetent economic management," he said.

Prime Minister Zhu Rongji ordered the shutdown

Now the big international banks are anxiously waiting to see whether any of the estimated $10bn they lent to these investment trusts will be at risk.

And now they may refuse to make further loans to Chinese investment trusts.

The Bank of China closed GITIC because "it could not pay maturing debts" - and they fear that other investment trusts may be suffering similar problems.

But some analysts believe that China's prompt action in dealing with its ailing financial sector will help it avoid a Japanese-style recession.

Foreign lending vehicle

The GITIC was essentially an investment bank where foreign banks were able to participate in the development of infrastructure projects during China's boom years.

The Bank of China had to take on the debts

These investment trusts were set up by the provincial governments to encourage the flow of funds into China.

Many international investors believed that their lending was guaranteed by the state.

But the trusts have become heavily involved in real estate speculation at a time when the property market is in a slump because of over-building.

GITIC was also involved in financing a superhighway from Hong Kong to the booming Guangdong region.

But the highly leveraged borrowing from overseas has become vulnerable. In the past Investment Trusts were able to roll-over debt by getting fresh loans from international bankers.

But this is no longer possible. Japanese and Korean banks in particular, which have provided 50% of the loans to Chinese investment, have been forced by their own troubles to pull back from further lending.

GITIC ran into trouble when it could not meet a $700m payment. Now it owes international investors $2bn.

But the Chinese government has said it will only honour fully documented foreign bank loans. Many loans were apparently made off the books to avoid foreign exchange controls.

The order to shut down GITIC was reportedly made directly by the Chinese Prime Minister Zhu Rongji, despite the protests of the Guangdong provincial authorities.

They are worried that other provincial investments could also be at risk.

Guangdong, opposite Hong Kong, has been one of China's fastest growing regions.

Bigger problems ahead

The problems at GITIC have served to highlight the dangers inherent in China's dash for expansion within a state-run economy.

Investment trusts have ignored government regulations, or used bribes to borrow heavily on foreign markets.

The former head of the Hunan International Trust and Investment Corporation has been sentenced to death for accepting a $250,000 bribe.

The danger for the Chinese government is that the unauthorised borrowing could make China more vulnerable to a run on its currency, the yuan, which is fixed to the dollar.

The yuan, or renmimbi, is not traded freely, but worries about its value have caused it to fall 8-10% on the informal market.

But the government has to be careful not to discourage foreign investment entirely, which it sees as one of the keys to modernising China.

That is one of the reasons why it has decided to rescue China's biggest investment trust, CITIC, which is now directly controlled by Beijing.

CITIC has major investments in Hong Kong, including a stake in China Light and Power, the main power company, and Cathay Pacific airline.

Most of its profits come from its Hong Kong subsidiary, CITIC Pacific, whose shares have crashed on the Hong Kong stock market.

Many analysts, including Moody's now believe that the company will have insufficient revenues to finance its $3.5bn in debts.

But given the lack of transparency no one knows the true state of its finances.

Now Beijing is to provide $300m to tide the Hong Kong company over and a further share collapse on the Hong Kong stock market.