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China could 'shock' markets with big GDP miss

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Weak trade data for China has left investors expecting more doom and gloom with next week's release of second-quarter numbers, and according to Lombard Street Research, the world's second-largest economy could shock markets with a quarter-on-quarter contraction in gross domestic product (GDP).

"Global markets could be due for a shock," Charles Dumas, an economist at Lombard Street Research said in a research note on Wednesday.

"Assuming the trade data are taken at face value, rather than some obscure adjustment being needed for the dodgy data vis-a-vis Hong Kong, there is an even chance that on our estimation procedure next week's real GDP will be down rather than up from [first quarter]," he said.

Monday's GDP data will be keenly watched by investors aware that the days of double digit growth are firmly behind China. A Reuters poll predicts a 1.8 percent quarter-on-quarter rise and a 7.5 percent rise on a yearly basis. That would be slowest pace of growth (year-on-year) since the third quarter of last year. But Dumas believes these figures could be generously overstated.

(Read More: Why China Delivered Such a Big Miss in Trade Data)

"This is not surprising, given the trade data, as the previous period of slumping exports, in the financial crisis, was not all that much more severe than the past few months."

Data showed on Wednesday that China's exports in June fell 3.1 percent from a year ago, marking the first decline since January 2012. The figures were well below expectations in a Reuters' poll for a rise of 4 percent.

Imports also missed by a wide margin, declining 0.7 percent year-on-year in June, compared to a forecast of a rise of 8 percent, and worse than the 0.3 percent drop in May.

(Read More: China Slowdown: This Rival Could Be a Winner)

"The poor data poses further downside risks to the June and [second quarter] growth numbers due for release on 15 July, and help reinforce our view that there is a 30 percent chance that China's GDP growth may drop below 7 percent in [the second half of 2013]," Nomura economists Wendy Chen and Zhiwei Zhang wrote in a research note on Wednesday.

The slowdown comes at a time when the country's new leadership is stepping up regulation, curbing an overheated credit market and switching an export-focused economy into a consumer-driven one.

So far the government has sent consistent signals that the policy stance will remain tight to contain financial risks, according to Nomura. But, if next week's numbers show further weakness, the government will face a decision on how much of a growth slowdown it is willing to tolerate.

'He Who Hesitates is Lost'

Lombard Street's Dumas believes that third-quarter growth could worsen because of tighter regulations being imposed by the government.

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"China is beginning to see the effects of both slow U.S. growth and euro zone recession, compounded by its own overvaluation and Japanese competition 'Abenomics' chiefly predicated on competitive devaluation," he said.

"Given the depth of likely resistance to policies that will harm the immediate interests of the leaders of many provincial governments, state-owned banks and other businesses, delay [in reforms] would have confirmed the adage that 'he who hesitates is lost'."

(Read More: China's Smog - What Are the Economic Costs?)

Alternative data used to gauge Chinese growth also shows economists' predictions are on the optimistic side and real growth in the country could actually be a lot worse

The "Keqiang Index," based on three sets of data that current Premier Li Keqiang used to monitor the economy when he was party chief in the Liaoning province in 2007, highlights that current growth could be worse than during the global crash of 2008, according to Patrick Chovanec, the managing director and chief strategist at Silvercrest Asset Management. The index measures economic progress via increases in power consumption, rail freight and bank lending and has diverged significantly since 2011 from official GDP readings.

But worries about a severe slowdown hasn't hurt Chinese stocks. The Shanghai Composite which has languished this year amid a global bull run, rose above the key 2,000 level for a second straight session on Thursday and hit a three-week high on hopes that the People's Bank of China (PBOC) will ease monetary policy in response to the slowdown.

By CNBC.com's Matt Clinch. Follow him on Twitter @mattclinch81.

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