The government is encouraging banks to restrain lending to certain sectors of the economy it fears are overheating, such as steel, construction and property.

'The encouragement of lenders not to lend to more speculative investments is actually producing a slowdown in the number of approvals and the number of applications for such investments,' Mr Ryan said. 'While that may not seem to be wholly significant, the impact on the economy generally and the pace of growth and new investment is significant.'

The Bank of China says it halved its lending in May to overheating sectors, but declined to specify which industries.

Some investors are concerned China may still have to increase interest rates to slow the economy. But Sun Hung Kai Securities strategist Edmond Lee does not believe interest rates will be increased in the near term.

'We believe it will be the last resort - they won't do it right at the moment,' Mr Lee said. He is pessimistic about the value of H shares in the short term, but says gains could be made next year.

'If we are talking about 2005 it is still okay to invest in H shares but ... for the rest of the year H shares are still in a consolidation phase,' he said. Mr Lee believes consumer goods and the power sector are good areas to buy into over the long term.

Tung Tai Securities associate director Kenny Tang urges investors to take a short-term trading approach towards China stocks as the huge returns of last summer in H shares will not be repeated. Mr Tang expects the economic slowdown may last more than six months, which will act as a hangover on share prices for months to come.

'If the share price goes up more than 10 to 15 per cent you should take profit and if the share price plunges substantially you maybe should bargain hunt,' he said.

Mr Tang believes many of the H shares still have strong potential but now is not the time for long-term investing. 'Most of the H shares are fundamentally still good, not too bad - the power sector, the toll roads, the port operators are enjoying very high growth,' he said.

Chief Asian strategist of ABN Amro Eddie Wong believes China shares are heading for a hard landing regardless of what happens to the broader economy. The reason? Massive over-investment coupled with the looming economic slowdown means corporate earnings are about to collapse.

He cites Maanshan Iron & Steel as a good example. Now trading at 6.5 times forward price/earnings, the steel producer may appear attractive to bargain hunters. However, Mr Wong cautions that a downward earnings revision in coming months could stretch valuations to 16 times forward price/earnings.

'It all depends what kind of 'e' we are talking about,' he said.

Despite the 35 per cent decline in H shares from the peak earlier this year, companies such as Maanshan Iron & Steel are still trading at two to three times the level of last year. He says the average H share is valued at 1.6 times price-to-book, well above the historical average during the past five years of 0.4 to 0.8 times price-to-book.

Mr Wong expects China's economic growth to slow to 6 per cent, a respectable rate he admits, but well below recent GDP expansion of 14 to 15 per cent. As the slowdown begins to bite, ailing state-owned companies are unlikely to cut wages or slash inefficient operations. 'They [central government] want to maintain social stability and not lay off too many people,' Mr Wong says of the government edicts that he expects will inhibit corporate restructuring. Without the ability to flush out excess capacity during the bear market, the inevitable result is sluggish earnings as companies struggle for pricing power in a deflationary environment.

Mr Wong estimates H shares will decline a further 40 per cent, with the bear market lasting another nine to 14 months. The H-share rout in 1993, which he says provides the best parallel for today's environment, took 13 months from peak to trough.

'We are not overweight on the China scene at the moment,' said Allianz Dresdner's asset management chief in Hong Kong, Mark Konyn. He is avoiding sectors that the mainland government is trying to slow down.

'We're keeping away from those sectors that have been earmarked as targets for action to cool the economy, i.e. property, commodities, steel, aluminium, autos,' he said. 'There are some consumption plays that we are still interested in which are more strategic in nature, [and] some of the export sectors.'

Last week ABN Amro upgraded the Hong Kong stock market to 'overweight' on the basis that the correction in share prices during the past four months has the market trading at a 'reasonable' 14.7 times forward price/earnings. In late February strategist Eddie Wong downgraded Hong Kong to 'underweight', arguing share prices were expensive, the US dollar was about to rally, and growing political tension between Hong Kong and Beijing would undermine market confidence.

Most of these issues have been resolved, he says. Importantly the US dollar, which began to strengthen in the early spring, now looks set for another bout of prolonged weakness, which should rekindle interest in local property and shares.

'We expect a weak dollar environment to re-ignite the domestic reflation theme, and Hong Kong is regarded as a major reflation play in the region,' he said. 'Hong Kong property prices rise when the US dollar, and hence the Hong Kong dollar, weakens.'

He recommends investors look to large property developers such as Sung Hung Kai Properties and Henderson Land, both of which are now trading at a discount to net assets. He also believes banks and related financial institutions should outperform.