Shares in a2 Milk - the market's biggest stock - slumped by more than 10 per cent after China said it planned to lift self sufficiency in infant formula manufacturing to 60 per cent from 40 per cent at present.
By the close of trading the stock was down by 11 per cent or $1.75 at $14.05 - its lowest point since late March.
A report in the China Daily said domestic companies were to be encouraged to develop new products for market.
The paper quoted a report from seven central government departments including the National Development and Reform Commission (NDRC), calling for a lift in self sufficiency.
Beijing-based New Zealand businessman and consultant David Mahon said the plan was not yet a formal policy but was a general statement of political intent.
The NDRC proposal said enterprises and institutes will be encouraged to work together on the research and development of new baby formula products to meet market demand.
"Increased competitiveness in the industry will help in the promotion of large-scale and automated production, the merger of small companies, and encourage domestic companies to buy or develop farms overseas to reduce costs, for example for improved technology or land," the China Daily said.
"With the adoption of the plan, baby formula produced domestically is expected to account for more than 60 per cent of the total supply, and consumers' confidence in domestic products will be significantly improved," it said.
Mahon said he doubted the shift would be a significant threat to Australasian infant formula makers.
He said the domestic infant formula manufacturing sector had to win back the faith of the consumers after the melamine-adulterated formula crisis of 2008.
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"The Government is trying very hard to improve its infant formula sector - not as a direct substitution for present imports, but just to make sure that there is a lot happening in an area where China is seeing all sorts of tariffs and barriers on goods globally," he told the Herald from Beijing.
For the medium term, the threat to Australasian and European suppliers of infant formula to China was "pretty low".
"It does signal that there is going to be a policy shift, backed by investment, to improve China's infant formula industry," he said.
"We should not see it a threat but we should not underestimate the determination of the Chinese Government to have some measure of sufficiency in any of the core food sectors," he said.
Salt Funds managing director Matt Goodson said a2 Milk was a stock that often attracted short selling, making for volatile movements up and down.
He did not expect China's plans for greater self sufficiency to have a big impact on the company, which specialises in products containing just the a2 beta protein.
"In short, what China is intending to do is encourage competition between domestic and foreign infant formula players," he said.
China has long wanted to consolidate the number of players to shut out the smaller operators, thereby reducing food-safety risks.
"Our sense is that the impact on a2 Milk should not be major," he said.
"We have seen these moves [in share price] before and they tend to be buying opportunities rather than selling ones," Goodson said.
"But there will certainly be a larger impact on the smaller players," he said.
A2 Milk is often targeted by short sellers - mostly in Australia where it is also listed.
Short selling involves traders borrowing stock to sell it and then buy back at lower levels.
In April, short sellers of a2 Milk were caught out after favourable research on the company saw its share price push sharply higher.
A2 Milk has come humble beginnings with its a1 beta-free brand of milk and infant formula products.
The company met with enthusiastic response in the Australian fresh milk market, where it has over 10 per cent market share.
Its success in Australia has acted as a springboard for China, where consumers have trouble digesting standard standard a1-a2 beta protein milk.
The company has a history of explosive earnings growth, thanks mostly to its success in China but also in Australia.
Early this year, chief executive Jayne Hrdlicka unveiled a 41 per cent lift in revenue to $613.1 million. A2 Milk's net profit after tax was $152.7m, up 55.1 per cent.
On the Australian share market, the share price for a2 Milk's far smaller competitor Bellamy's was about 4 per cent weaker.
A2 Milk's sharp decline was the main driver of the S&P/NZX50 1.7 per cent fall to 9952 by the close.
The partly a2 Milk-owned Synlait Milk - which is currently embroiled in a land dispute at Pokeno - dropped 22c or 2.4 per cent to $8.65, but well off its lows for the day.
Craigs Investment Partners' head of private wealth research, Mark Lister, said the market was mostly playing catch-up with weakness in foreign markets.
"A2 Milk is a high-growth, high-return stock, so it's always going to fall harder than the average," he said.