China Clamps Down on Drug Manufacturers

China, a fast-growing country of more than 1.3 billion people, appears to be growing faster than some lawmakers there would like. The economic benefits that come with a GDP slated to grow at 9.6% this year, according to the International Monetary Fund, also carry a downside risk -- inflation.

Inflation figures for February came in at 4.9%, nearly its highest level in two years and a figure that will in all likelihood head higher. Rising energy costs and climbing commodity prices for food and metals have forced the Chinese government to come up with new and innovative ways to protect its citizens from ballooning costs.

To cope with these rising costs, the National Development and Reform Commission, China's state planning agency, outlined a plan to cap the price of certain drugs. The new price cap, which went into effect Monday, will cut the price of more than 1,200 drugs sold within China by an average of 21%.

This measure does hold promise in the hopes of curbing excessive charges by Chinese hospitals on citizens, but it's a dismal scenario for drug manufacturers that operate out of China, both foreign and domestic.

Pfizer (NYSE: PFE), Novartis (NYSE: NVS), GlaxoSmithKline (NYSE: GSK), and sanofi-aventis (NYSE: SNY) are the drug manufacturers most directly affected by the new price cap. These companies, particularly Pfizer, market multiple drugs through joint ventures with Chinese pharmaceuticals and could see an impact to their bottom lines in China because of the price cap. However, it needs to be understood that these companies are also multinational drug juggernauts with tens of billions in revenue each year, and all will likely absorb this blow without much affect to their earnings capability.

The real losers here appear to be small-scale Chinese drug manufacturers who don't yet have an international buffer to fall back on. The landscape of small-scale Chinese drug manufacturers is already very thin once you move beyond generic or traditional Chinese medicines. This new measure may wipe out any upstart drug manufacturer without a large foreign partner or curb research and development from other small-scale manufacturers.

I understand that China wants to curb inflation and protect its citizens, but this new price cap may in turn crush its domestic drug manufacturers and solidify foreign pharmaceuticals' dominance on its soil. We're only two days into this new legislation, so there are still a slew of unanswered questions and possible outcomes, but from an investment perspective, I don't see very much to be excited about.

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