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Why China's slowdown spells trouble for Europe

Port Of Hamburg
Krisztian Bocsi | Getty Images
Port Of Hamburg

China's growth data may have been welcomed with a sigh of relief by markets, but it is unlikely to reassure Europe's powerhouse Germany, which is already experiencing a rapid decline in exports to the country.

Around 6 percent of Germany's exports go to China – its fifth largest trading partner in 2012 in terms of exports. Some 67 billion euros ($87 billion) of goods were shipped to the Asian nation last year, compared with 104 billion euros to France and 87 billion to the United States.

But China's gross domestic product (GDP) slowed in the second quarter, coming in at 7.5 percent year-on-year, down from 7.7 percent in the first three months of the year. It followed disappointing import data for China, which missed expectations by a wide margin last Wednesday, declining 0.7 percent year-on-year in June, against a forecast of a rise of 8 percent.

"A Chinese slowdown would indeed be a cause of concern for the German economy," Carsten Brzeski, a senior economist at ING based in Brussels, told CNBC, adding that if it turns into a longer-lasting investment drought, it would mean a lot more than just a temporary drop in car sales for German firms.

(Read More: Goldilocks Chinese GDP a little too perfect for some)

The poor run of data 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 signaled that its monetary policy stance will remain tight to contain financial risks, but this latest round of data is set to test its resolve further on how much of a growth slowdown it is willing to tolerate.

"The big story is [China's] inability to finance the investment boom, and the fact that the investment boom is collapsing under its own weight - that's what's really has been driving Chinese growth up until now," Patrick Chovanec, managing director and chief strategist at Silvercrest Asset Management, told CNBC on Friday.

'Fundamental weakness'

This slowdown in China has already impacted some German companies, which have reported weakness in exports to the country.

Bentley, owned by carmaker Volkswagen, said last Wednesday that it delivered only 817 cars to China in May, a 23 percent decrease on last year. Siemens also said it was starting to feel the heat. The engineering giant said customers had taken a cautious approach to waning growth in emerging markets in its latest earnings report. It expects slowing growth to continue into the fiscal 2013 year, especially in peripheral Europe and China.

(Read More: Watchout: China's growth could fall to 4-5% by 2020)

Seasonally-adjusted exports for Germany tumbled 2.4 percent in May, its steepest fall since December 2009, according to data from the Federal Statistics Office. Exports to countries outside Europe slipped 1.6 percent, the Office said.

"The German economy is not as strong as people think. It has a big trade surplus, but that is not the same thing as a growing economy," Matthew Lynn, founder of Strategy Economics, told CNBC. "Exports are slowing, domestic demand is weak, the banks are exposed to peripheral Europe, the population is declining, and the government has too much debt to take up the slack."

If German exports to China continue to slow, it would be bad news for the euro zone as a whole, as Germany is the region's largest economy.

Charles Dumas, an economist at Lombard Street Research, said China could ruin any slim chances of a European recovery in the second half of the year.

"Europe may achieve a lesser rate of recession, maybe even a temporary uplift from the inventory cycle, but its dependence on German capital goods exports to China and other emerging markets is a fundamental weakness that could renew recession soon," Dumas said in a research note on Wednesday.

(Read More: Business confidence back to financial crisis lows)

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