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8.6% China growth next year? What's Deutsche 'smoking?'

Markets are underestimating China's 2014 growth potential, say analysts at Deutsche Bank, whose forecast is far above consensus expectations.

Most analysts expect the world's second-largest economy to expand at a rate of 7.5 percent in 2014, but Deutsche Bank sees much stronger growth at 8.6 percent.

When jokingly asked by CNBC's anchors what the analysts were smoking at Deutsche Bank, because their forecast is so far above consensus, Taimur Baig, chief economist for Asia at Deutsche Bank replied: "We're smoking reality."

(Read more: Forget a slowdown, China's economy set to accelerate)

"Of course, China is slowing, given adverse demographics and the ongoing shift from manufacturing to services, we all know that story. And of course we fully understand the drag coming from the financial sector," said Baig.

"Our point is, on a cyclical basis, the market is underestimating the bounce that China will get in 2014," he added.

Pedestrians on Nanjing Donglu shopping street.
Krzysztof Dydynski | Lonely Planet Images | Getty Images
Pedestrians on Nanjing Donglu shopping street.

2013 has been a volatile year for Chinese investors, who have attempted to navigate uncertainty over policy makers' agenda and fears over slowing growth. Meanwhile, a number of overhanging risks, such as worries over the bubbles forming in the nation's property and credit markets, and concerns over shadow banking, have also put investors off.

(Read more: Behind China's shadow banking system)

But according to Deutsche Bank there are a number of major drivers set to propel economic growth forward next year. One will be a strong pick-up in external demand for Chinese exports; another will be the boost the economy will get from deregulation, following the bold reforms announced following the Third Plenum in November.

(Read more: Breakthrough rally for Chinese stocks (finally))

"Improvement in global demand, especially from G3, will boost demand for Chinese exports," said Baig.

"[On] the deregulation side... that's where we think the market is missing out. We see a post-plenum bounce of cutting capacity in industries that have excess, and building capacity in industries that don't," he said, adding that he expected healthcare and public housing to get a particular boost.

Furthermore, Baig added that the central bank's expected financial regulation reform, which is said to involve the liberalization of interest rates and freer trading of the renminbi amongst other things, should also work to get the market "humming again."

"It's not just one or two tricks. We have a five pillar narrative that will drive this 8.6 percent growth, which is, yes, significantly above consensus," he added.

(Read More: China 2014 growth target: To cut or not to cut?)

The Deutsche Bank chief economist acknowledged, however, that there were overhanging risks to the market, including the $6 trillion annual shadow banking industry in China, which has in the past led to taxpayers having to bailout mainstream banks, together with concerns about the relationship between banks and SOEs.

"The shadow banking industry... and the unholy relationship between SOEs and the banks needs to be cleaned up. [But] in an economy that is broadly closed capital account wise, one can't really have a massive capital outflow just because people are worried about the banks," he added.

By contrast the Royal Bank of Scotland sees China growing 8.2 percent in 2014, while analysts at Nomura have a much more bearish forecast at 6.9 percent.

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

Contact Asia Economy

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