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Now, China Watchers See Growth Below 7%

Jens Schott Knudsen | Flickr | Getty Images

China's gross domestic product (GDP) growth could slide below 7 percent in the second half of the year, warned Nomura, highlighting that downside risks to the world's second largest economy's outlook have risen "significantly" in recent weeks.

Tighter liquidity conditions and minimal support from policymakers, coupled with weakness in external demand, pose a threat to the country's growth trajectory, according to Zhiwei Zhang, chief China economist at the investment bank.

Nomura has assigned a 30 percent probability to the scenario unfolding, noting that its current base case is for growth to slow to 7.4 percent in the third quarter and 7.2 percent in the fourth quarter.

(Read More: This China Downturn May Be the 'Most Drawn-Out')

"Official total social financing has tumbled in recent months. We believe the series of policy tightening measures applied to the shadow banking sector in the past three months has reached a critical mass, such that deleveraging in the banking sector is happening," said Zhang.

"Liquidity tightening can be very damaging to a highly leveraged economy. Many local government financing vehicles rely on new debt issuance to pay the interest on their outstanding debt because they are operating-cash-flow negative," he added.

Total social financing, a broad measure of liquidity in the economy, fell to 1.2 trillion yuan ($195 billion) in May from 1.7 trillion yuan in April and 2.5 trillion yuan in March, according to Nomura.

As financing costs rise, it will make it difficult for local governments to sustain their projects, which in turn will weigh on fixed asset investment in the coming months, Zhang said.

And, with policymakers appearing to be more tolerant of lower growth rates, he believes it is unlikely the government will step in with stimulus.

Last weekend, for example, Premier Li Keqiang said current economic growth was within a "reasonable range" in spite of a recent slew of disappointing economic indicators including trade data for May, which, showed exports growing just 1 percent from a year earlier and imports sliding 0.3 percent.

(Read More: China Data Highlights Weak Economy, Remedies in Focus)

Weakness in external demand is the third factor that could limit growth in the mainland, Zhang said.

"Emerging markets face downside risks as the potential Fed exit from quantitative easing has led to capital outflows from these economies. China's exports depend increasingly on emerging markets, hence a slowdown in these economies poses a risk to China's growth outlook," he said.

Over the course of the second quarter, investors have become more wary about the outlook for China's economy, with key manufacturing and export sectors increasingly exhibiting signs of weakness.

This had led to a slew of downgrades by banks, with Morgan Stanley the latest to lower its annual growth forecast for China to 7.4 percent this week. China's official target for the year is 7.5 percent.

By CNBC's Ansuya Harjani

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