European hedge fund managers are betting that China’s once red hot economicchina riots photo growth will cool dramatically in 2012, hitting companies, economies and commodity prices that have been fuelled by the world’s second largest economy in recent years.

Managers are taking bets ranging from short positions on equity markets or the currency to buying credit protection on companies that export to China. Others are shorting natural resources stocks in other countries that rely on Chinese demand.

“China is an inflated castle in the air,” said Pedro de Noronha, managing partner at London-based hedge fund firm Noster Capital, who is using futures to short Chinese H-shares and is also holding a short position on the yuan.

“We’re quite skeptical and worried,” he added. “China needs a healthy U.S. … consumer and it’s not getting it right now…. China could be a catalyst for a severe leg-down in markets,” he said.

He also cited recent cases of fraud in China and the country’s booming real estate sector as issues.

“Corporate governance and the rule of law is very different from the West,” he said. “(And) there’s a huge bad loans issue in banks. The real estate market is probably in the biggest bubble in the world we have right now.”

China’s rampant economy, which recorded double-digit growth every calendar year between 2003 and 2007, has shown signs of cooling of late, as global demand slackens amidst slowing growth in major economies and Europe’s deepening debt crisis.

GDP growth, set to be published on Tuesday, is forecast to have slipped to an annualized 8.7 percent in the three months to December, raising the possibility the Chinese government may unveil new policy steps to avert a hard economic landing.

Meanwhile data last week showed exports and imports grew at their slowest pace in more than two years in December and inflation fell to a 15-month low.

Full article here.

H/T ewallstreeter