By Joanne Chiu and Xie Yu

China's main stock benchmarks tumbled, erasing all of this year's gains, as investors grappled with signs that policy makers in Beijing will take more action to rein in debt and prevent asset bubbles from forming.

The CSI 300--an index of the 300 largest stocks listed in mainland China--fell 3.5% Monday while the Shanghai Composite Index dropped 2.3%, hitting their lowest closing levels in 2021. The CSI 300 is now in correction territory, having declined more than 10% from a recent peak on Feb. 10, just before the start of the Lunar New Year holiday.

Chinese stocks have been trending lower in the past few weeks, after an earlier run-up and stellar 2020 performance that was underpinned by the country's return to economic growth during the Covid-19 pandemic.

Top Chinese financial regulators recently warned about the risk of asset bubbles forming in domestic real-estate prices and global financial markets. Last week, Chinese leaders also indicated they could renew their focus on curbing debt levels now that the economy is on firmer footing. China was the only major world economy to report growth in 2020; it expanded 2.3%.

At Friday's opening of the National People's Congress, the annual session of China's legislature, the government said it is targeting gross domestic product growth of 6% or more this year. The new goal was lower than many economists' predictions that China would expand by at least 8% and was taken by some as an indicator that Beijing expects growth to moderate while it takes steps to curb debt-related risks.

Chinese leaders also scaled back their targets for inflation and the country's fiscal deficit, which "effectively makes room for authorities to deliver policy to deflate the bubble to avoid systemic risks," strategists from Citi Private Bank said in a Monday research note.

Some of China's most valuable stocks led the recent declines. Kweichow Moutai Co., a state-owned maker of high-priced spirits, has lost nearly a quarter of its value since Feb. 10, when the Shanghai-listed company was valued at around $500 billion. Shares of Wuliangye Yibin Co., another producer of a fiery liquor known as baijiu, have fallen by a similar magnitude. Both stocks are components of the CSI 300 index.

Moutai, the world's most valuable liquor company, has in the past been a target of Chinese authorities' attempts to cool stock-investment frenzies.

Conversely, shares of Ping An Insurance Group, which is also part of the index, have chalked up gains over the past month.

Some of the earlier run-up in Chinese stock prices overall was driven by large inflows into mutual funds, which have become popular with investors on the mainland.

But after a significant increase in valuations, a lack of good news coming out from the legislative meetings this month has given investors pause, said Thomas Kwan, chief investment officer of Harvest Global Investments, the offshore unit of one of China's largest asset managers.

"A correction is easily triggered," he said.

Some money managers are currently holding more cash as they await additional policy direction from China's central bank and clarity over the economic growth outlook, said Gary Zhang, a partner at Shenzhen Grand Gold Capital Co.

Wendy Liu, head of China strategy at UBS Global Research, said she expects the longer-term upward trajectory of the CSI 300 index to remain intact. The recent pullback is a consolidation of what she called a "slow bull market" and creates opportunities for investors to buy into companies with market-leading positions and strong earnings growth. She added she still sees the broad benchmark rising about 20% from current levels by the end of this year.

Write to Joanne Chiu at joanne.chiu@wsj.com and Xie Yu at Yu.Xie@wsj.com

(END) Dow Jones Newswires

03-08-21 0601ET