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Goldman Joins Bandwagon, Downgrades China

An investor watches the electronic board at a stock exchange hall in Huaibei, China.
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An investor watches the electronic board at a stock exchange hall in Huaibei, China.

Goldman Sachs became the latest bank to downgrade China's economic growth on Monday, saying tighter financial conditions and reforms are downside risks for the world's second largest economy.

The bank cut China's gross domestic product (GDP) growth forecast for the second quarter to 7.5 percent on the year from 7.8 percent previously. It also revised full-year growth estimates to 7.4 percent for 2013 and 7.7 percent for 2014, from 7.8 percent and 8.4 percent, respectively. The official growth target for the year is 7.5 percent.

"The recent tightening of the interbank market has sent a strong policy signal that the strong credit growth earlier in the year will likely not continue," Goldman said in a note. "We estimate this to tighten the FCI [fixed capital investment] by another 30-40 basis points in the coming months, in addition to the FCI tightening of 100 basis points so far this year driven by the rapid yuan appreciation on a trade-weighted basis."

China's money market rates hit a record high last Thursday with the seven-day repurchase rate, a measure of interbank funding availability, rising above 10 percent, while the overnight repurchase rate jumped as high as 30 percent, creating panic among investors.

Despite the ongoing liquidity crunch, the country's central bank - People's Bank of China (PBOC) - has been reluctant to pump in cash and alleviate the credit squeeze. The bank said on Monday that overall liquidity in China's financial system is at a reasonable level, Reuters reported. Interest rates were off last week highs, but still at elevated levels on Monday.

(Read More: What's Really Behind China's Cash Crunch )

China's recent attempts to tame informal lending and slow credit growth shows the government has focused priorities on reforms over growth, Goldman said.

"These policies help to foster more sustainable medium-term growth, but will test the government's tolerance for a cyclical downturn," Goldman said, adding that reforms from policymakers will be negative for economic growth in the near term.

Goldman has joined a slew of banks and international agencies that have downgraded China's economic growth forecast in recent weeks, citing the government's tolerance for slower growth amid implementing structural reforms. Nomura is going as far as to predict that GDP growth may fall below 7 percent in the second half of the year. China's economy grew at its slowest pace for 13 years in 2012.

(Read More: Now, China Watchers See Growth Below 7% )

Fears of a hard landing in China have also been heightened by a series of economic data pointing to a pronounced slowdown in the second quarter. The closely-watched flash HSBC Purchasing Manager's Index (PMI) fell to a nine-month low of 48.3 in June, worse than the final reading of 49.2 in May when the index moved into contractionary territory for the first time in seven months.

(Read More: China PMI Slump Will Test Authorities' Resolve )

- By CNBC.com's Rajeshni Naidu-Ghelani; Follow her on Twitter @RajeshniNaidu

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