What if China lands hard? SocGen outlines the scenario
Investors are getting complacent about the likelihood of a China hard landing this year, which has become a real and "non-negligible" risk, investment bank Societe Generale (SocGen) has warned.
In the bank's extreme scenario, Chinese growth could plummet to under 6 percent this year, and as low as 3 percent in the second half of 2013 and the first half of 2014. In such an event, base metals will crash by 40 percent.
(Read more: Is China about to launch a new round of stimulus?)
"We think many investors may still be relatively complacent about the risk of a hard landing. This could prove a costly mistake," SocGen said its July strategy report.
The bank stressed, however, that a hard landing is an extreme view; the bank's core projection remains that China would have more of a "bumpy landing over the medium term where growth grinds persistently lower from 7.4 percent in 2013 to 6 percent in 2017."
Investors have grown increasingly concerned about slowing growth in China, in light of recent poor economic data.
On Tuesday, a private survey of manufacturers showed factory activity remains sluggish. The China HSBC flash purchasing managers index fell to an 11-month low of 47.7 in July, which means the sector has been in contraction for a third straight month.
Many investment banks and market watchers in recent weeks have also cut their growth targets for China, with many expecting the economy to miss the government's official 7.5 percent annual growth forecast this year.
(Read more: IMF sticks to 7.75% growth target for China)
According to SocGen's China economist Wei Yao, two types of events could trigger a hard landing in China, which she classifies as a fall in growth to under 6 percent, the minimum level required to keep the job market stable and avoid systemic financial risk.
"Trade shocks leading to a sharp deterioration in exports and loss of migrant worker jobs could be one potential trigger," Yao said.
"Second, a hard landing could be provoked by either insufficient public investment from Beijing or an intended credit deleveraging going out of control," she added.
If China were to hard land, global gross domestic product (GDP) would be halved from 2.6 percent to 1.3 percent in 2013, SocGen said.
(Read more: Fuzzy numbers? Real China growth only half: Expert)
As China accounts for 40 percent of base metals consumption, a hard landing would lead to a 30-40 percent drop in base metal prices and a 30 percent fall in Brent crude oil prices, the bank's global head of commodities research Mike Haigh said.
Meanwhile, gold prices could initially bounce on a Chinese hard landing, Haigh said, although as Chinese savers are large buyers of gold, the impact could be short-lived and volatility could rise.
The greenback would rally against all the other major currencies, including Asian and emerging market currencies.
However, if China embarks swiftly on a program of reform, China policy makers should be able to mitigate the negative impact of massive resource and credit misallocation, the report said.
"The assumption is that the new leadership will somehow succeed in gradually deflating the existing bubbles through carefully sequenced reforms," said the report.
"However, (there's) the other possibility - not a small one - that this slow bursting process may get out of the control at some point and morph into a much sharper correction. In other words - a hard landing."
—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie