General Motors (NYSE:GM) has just been hit by an anti-monopoly probe in China, its largest market. Chinese regulators are investigating Shanghai GM -- a joint venture between GM and the state-owned Shanghai Automotive Industries Corp., which sells GM's Buick, Cadillac, and Chevrolet vehicles.

Source: Wikimedia Commons.

GM is just the latest foreign automaker to be investigated -- Volkswagen's Audi just agreed to pay $40 million for alleged violations, Chrysler faces unspecified penalties, and offices at Daimler's Mercedes-Benz were raided by the government. Toyota's Lexus brand and other Japanese auto parts suppliers are also being scrutinized.

China argues that it is responding to complaints of price gouging. Foreign automakers, however, believe that China is throttling their growth to help its domestic auto industry, which only accounts for 37% of the market.

Why China matters to General Motors
China surpassed the U.S. as GM's largest market last July. GM is China's second-largest foreign automaker after Volkswagen. It sold 1.73 million vehicles in China in the first half of 2014,  a 10.5% increase from the previous year. By comparison, GM's sales in the U.S. rose just 2.8%, to 1.46 million vehicles during the first half.

GM and other Western automakers also have an edge over Japanese competitors in China, due to anti-Japanese sentiment fueled by political clashes, most recently over the Senkaku Islands dispute and the remilitarization of Japan. In 2013, the big three Japanese automakers -- Toyota, Nissan, and Honda -- all suffered double-digit output declines as a result.

China also still loves the Cadillac, GM's ailing luxury brand. Sales of Cadillacs in China surged 72% over the prior year, to 33,760 units in the first half of 2014. By comparison, Cadillac sales in the U.S. fell 1% over the prior year, to 82,068 units in the first half of 2014 as it lost market share to BMW, Mercedes-Benz, and Audi.

Considering that McKinsey & Company expects China to become the world's largest market for luxury cars by 2020, GM could position Cadillac in China as an alternative luxury brand to BMW, Mercedes, and Audi -- which control a combined 80% of China's high-end market. GM believes that it can sell 300,000 Cadillacs in China annually by 2020 and claim 10% of that market.

China's low-end market also matters to GM. Through SGMW, its SAIC-GM-Wuling Automobile joint venture with SAIC Motor and Lizhou Wuling Motors, GM sells cheap, $5,000-$10,000 vehicles with remarkable fuel efficiency of up to 40 miles per gallon. SGMW sold 883,724 vehicles during the first half of 2014.

SGMW's $7200 Wulin Rong Guang Minivan. Source: Wikimedia Commons.

Is GM overcharging Chinese customers?
Unfortunately, GM's big dreams of Chinese sales offsetting losses in the U.S. aren't going to come true if it gets vilified as a price gouger.

Most foreign automakers blame taxes for the higher prices in China. China charges a 25% import tax, a 17% value-added tax, and a consumption tax based on engine size. But the prices of some imported vehicles don't seem fully justified by taxes. BMW's X5 luxury crossover, for example, costs a whopping $330,000 in China compared to $103,000 in the U.S. To deal with that import tax, most foreign automakers sign joint ventures with Chinese companies to manufacture them in China.

GM's high-end prices seem comparably reasonable. GM's entry-level Cadillac ATS starts at $33,065 in the U.S., and it debuted in China at $49,000. To narrow the price gap, GM is building a $1.3 billion Cadillac plant in China to avoid the import tax. The plant is expected to locally manufacture the Cadillac SRX crossover, which sold 14,496 vehicles in the first half of 2014 -- a 23% year-over-year increase that accounted for more than 40% of Cadillac sales across China. The imported SRX currently costs more than $67,700 in China, compared to a starting price of $37,605 in the U.S.

GM's Cadillac SRX. Source: Wikimedia Commons.

In a statement issued to AP, Shanghai GM defended its prices, saying the components that make up a vehicle would cost 265%-330% of the entire vehicle's price if purchased separately, which is in line with its 300% ratio in American and European markets.

The Foolish takeaway
In the past, China was a rare bright spot for GM investors. Soft U.S. sales didn't matter compared to surging Chinese sales. Distaste for Cadillacs in Western markets was offset by fresh demand from a rising middle class in China. Most important, 29 million recalls in 2014 still didn't dent its double-digit growth.

Unfortunately, GM is now in the crosshairs of the Chinese government. In my opinion, the Chinese government might go easier on GM, considering that it is only investigating one joint venture -- with a state-owned company -- out of the 12 joint ventures it has in the country. Nonetheless, it's still a troubling development that comes at a dark time for GM, which is still weighed down by 13 years of recalls.