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The Risk That Markets Aren’t Fully Bracing For

Monday, 8 Jul 2013 | 7:40 PM ET
Amanda Hall | Robert Harding World Imagery | Getty Images

Economists may have lowered forecasts for China's economic growth, but markets are still not fully factoring in what weakness in the world's second largest economy means for the rest of the globe, analysts say.

"The problem in Europe, if there is one, is going to come through Germany, and is one that people really aren't focusing on right now," Mark Matthews, head of research for Asia at Bank Julius Baer, said on CNBC late last week.

"Over half of Germany's GDP [gross domestic product] is from exports and I think the slowdown in China has not been embedded into most forecasts around the world," he said. China is the biggest non-European Union market for German exports after the United States.

China's economic numbers have proved mostly weak lately, prompting a number of banks to revise down their 2013 growth forecasts. HSBC and Goldman Sachs now expect China's economy to grow 7.4 percent this year – which would mean falling below Beijing's target of 7.5 percent.

(Read More: Why China's Economy May Be Heading for a Crash)

Concerns over China's slowdown are already being felt in Australia's markets. Weaker-than-expected data from China have contributed a fall in the Australian dollar this month to a three-year low against the U.S. dollar. China is Australia's main trading partner and Aussie markets are, to some extent, seen as a proxy to what is happening in China.

China: Going from Roaring Growth to Boring Growth?
Gary Greenberg, head of emerging markets at Hermes Fund Managers, tells CNBC that the major issue in China is the general liquidity crisis in the economy.

But the broader risks to global growth from a slowing Chinese economy, which Beijing appears happy to tolerate for now, are not fully appreciated, say analysts.

Apart from its close economic ties to Europe, China is also one of the U.S.'s biggest trading partners and the main trading partner for most Latin American countries as well as big Asian economies such as Japan and South Korea.

(Read More: The Biggest Risk for Asian Markets (It's Not China))

"China's neighbors are watching closely. In recent years, it was demand from the mainland, much more than the gradually recovering United States, that sustained growth in Asia. Take Korea. It now exports more to China than to Europe and the U.S. combined," said Frederic Neumann, the co-head of Asian economics research at HSBC, in a note on Monday about how developments in China and not the U.S. could be more crucial for Asian markets.

According to Tim Condon, the head of research for Asia at ING Financial Markets, there is a danger of reading too much into the weakness in China's economy.

"Consensus forecasts at the start of year were for Chinese GDP growth just above 8 percent and now it's below 8, so that's not a huge change," he said.

(Read More: China Is Slowing, but One Business Keeps Growing)

"The worry for China is that the cuts continue and that growth ends up being lower than authorities expect. But that is a risk case, not the central case," he added.

Still, investors might be right to pay closer attention to developments in China compared with the focus on when U.S. monetary easing may be unwound, analysts said.

"What matters for financial health is not the level of interest rates but the degree of confidence in future returns. A Fed that embarks on a gradual withdrawal of monetary stimulus is not a risk-off event. It's just about re-pricing. But a storm on the Mainland [China] would undoubtedly prompt financial caution across emerging Asia," said HSBC's Neumann.

-By CNBC's Dhara Ranasinghe; Follow her on Twitter: @DharaCNBC

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