If you could put China's problems in a bottle…

February 11, 2013: 11:39 AM ET

You'd have Maotai. An anti-corruption agenda, a price-fixing investigation, and ongoing questions over contamination have put China's favorite liquor in a tough spot.130211043707-kweichow-moutai-gallery-horizontal

By Diana Bates

FORTUNE -- Maotai is one liquor that refuses to go down easy -- on stock exchanges or otherwise. It is big-flavored and bracing, with a history that reaches back to China's Song dynasty. But recently, the popular Chinese spirit has fallen on hard times.

It began with the discovery of toxic contaminants in other sorghum-based liquors at the end of November made by a smaller producer, Jiugui Liquor. A report in the Guangzhou-based newspaper 21st Century Business Herald led to an investigation by China's food safety regulator, which confirmed excessive levels of the plasticizer dibutyl phthalate in several of the company's products. The liquor industry in China took a beating in the stock market in the wake of the news.

By early December, rumors began to circulate that Kweichow Moutai Co., China's biggest liquor producer by market value, was also dealing with similar contamination problems, based on test results posted by a blogger on Sina.com (these results have not been confirmed by official regulators). The Renhuai-based company took a high-handed tone in addressing the rumors, which did little to smooth things over. "Moutai does not have the obligation to, nor does it intend to, test the products in question," said a company representative in a statement.

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Kweichow Moutai's share price slid so fast that it suspended trading of its stock in mid-December. The company has seen a 28% share price drop from a peak last year in July.

Kweichow Moutai, which is known as the "national liquor" in restaurants across China, is imbibed at high-level state banquets and still holds currency as a preferred gift for government officials. At upscale locations such as the Ritz-Carlton in Beijing, a 50-year vintage goes for $78,888 yuan (about $12,700 USD) per bottle. A bottle at a local liquor shop for the lower-end Feitian can go for roughly $1,500 yuan ($240 USD).

Like just about any luxury brand, Kweichow Moutai differentiates itself from competitors through its aura of exclusivity. Maotai's mythical roots go back to the hillsides of Guizhou Province, when the Red Army made camp in the eponymous township during the Long March and sampled the local sorghum brew. But much of the liquor's luxury power has been fueled by unsatisfied desires stemming from a centrally planned economy that issued ration coupons for purchases from 1955 to 1993.

The tickets, called "liangpiao," seldom covered liquor. Urbanites would wait in line for hours to exchange cash and ration tickets for staples like cooking oil and grain. At best, a work unit might add coupons for dried watermelon seeds, salted peanuts, and a ribbonfish for the holiday dinner table. Maotai never made it to the list of essentials.

So when Kweichow Moutai came face-to-face with persistent questions over quality, a plummeting stock price, and slower sales, the company quickly leaned on its most potent associations for assistance.

At a distributor's conference in mid-December, Kweichow Moutai rolled out market allocation policies in the form of a price-fixing plan. Among other restrictions, the popular 106-proof Feitian could not fall below 1,519 yuan per bottle at retail shops, the company decreed. A company representative stated at the conference that non-compliant dealers would be punished with either fines or cancelled contracts.

The government finally stepped in. On January 16, Kweichow Moutai said it would retract its base price requirements. And China's top economic planner, the National Development and Reform Commission, launched an investigation into complaints of unfair practices by Kweichow Moutai.

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Meanwhile, recent changes among China's leadership may lead to a decline in Kweichow Moutai's core consumers: government officials. President-in-waiting Xi Jinping plans to pursue an anti-corruption agenda, which has raised speculation that the Kweichow Moutai could take a major hit in the years to come. For decades, the iconic white ceramic bottle has been synonymous with long, boozy dinners paid for by the state. Indeed, Maotai falls under what is called the "three publics," a reference to  expenditures by officials that include overseas visits, government vehicles, and entertainment. China's Central Military Commission announced in December that it would seek to cut down on entertainment expenses by banning expensive liquor at banquets, and provincial governments have since made similar announcements.

To be sure, initiatives to cut down on luxury spending by government officials have failed in the past, but some analysts are adamant that the government means business this time. Brokerage firm Huatai Securities issued a report January 30 stating it expected the real estate, luxury goods, and liquor industries to take a hit amid the renewed anti-corruption campaign by China's central government.

So will Kweichow Moutai continue to struggle during the year of the snake? Perhaps, but only if the state-owned company is willing to make some changes. For now, though, it looks like the company won't be abandoning its urge to push forward, just as it is. On the company's recent woes, Kweichow Moutai Chairman Yuan Renguo said at a provincial government meeting in late January, "After the rain always comes the sun."

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