China Industrial Profits to Show Worsening Economy

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China's economic woes are set to continue this week as Thursday's industrial profits data are expected to mark the start of a weakening trend, analysts told CNBC.

As the slowdown in the economy takes hold and China's industrial sector struggles with over-capacity, profit growth for the month of May likely slowed to 7-8 percent, analysts say, and will continue to soften in the coming months.

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"I expect industrial profits will be weak over the next few months, dropping into negative territory by the end of the third quarter of this year," said Zhiwei Zhang, chief China economist at Nomura International, who forecasts industrial profits for May grew to around 8 percent, a 1.3 percent decline from April's 9.3 percent rise.

China's gross domestic product (GDP) growth in the first quarter of 2013 disappointed expectations, coming in at 7.7 percent, below hopes of 8 percent growth and reigniting fears of a hard landing in the world's second largest economy. Some economists are now concerned China will not meet its official target of 7.5 percent expansion for this year.

This week's cash squeeze, that saw money market rates skyrocket and led to panic among investors, highlighted the dangers facing China's economy and pointed towards a further slowdown as the government reins in rampant bank lending.

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Analysts told CNBC that a marked slowdown in certain segments of China's industrial sector, namely steel, are dragging overall profits down in a clear sign of a slowdown.

"Sectors like steel, cement and chemicals are being under-utilized, and suffering from over-capacity," said Rajiv Biswas, Asia-Pacific chief economist at research house IHS Global Insight. "This is because demand is sluggish and there is too much capacity. Profit conditions are suffering downward pressure."

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According to Biswas, the future for China's industrial sector looks bleak given recent lackluster data. Earlier this month official data showed that Chinese exports in May posted their lowest growth rate in almost a year, while the preliminary HSBC China Purchasing Managers' Index fell to a nine-month low of 48.3, signaling a contraction in factory activity.

"There is no real sign of the economy picking up," said Biswas.

"My hunch is between 7 percent and 8 percent [for industrial profit growth]," said Li-Gang Liu, chief economist and head of Greater China economics at ANZ Research. "Industrial profits are going in a weaker direction, and I see this continuing for a while," he added.

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A stronger domestic currency, which has dampened external demand for Chinese goods, and weakening producer prices, which fell 2.9 percent year on year in May, are damaging companies' pricing power, he said.

Furthermore, the recent increase in cash rates in China had further squeezed corporates.

"Surging money market rates will lead to increased borrowing costs for corporations this month and next month, which will impact negatively on earnings capacity," added Liu.

Money market rates in China remain at high levels, with the seven-day repo rate standing at around 7.2 percent on Thursday. It had hovered between 2 percent and 4 percent for most of the year until credit conditions started to tighten earlier this month, taking the rate to over 10 percent last week.

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—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie