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Heads up! Both the IMF (International Monetary Fund) and OECD (Organization for Economic Cooperation and Development) just announced that they’re expecting weaker growth in China this year. The IMF projected that the Chinese economy will expand by only 7.75% in 2013, down from the 8% growth estimate they gave a few months ago.

Meanwhile, the OECD downgraded its 2013 GDP growth forecast from 8.5% to just 7.8%. Other private financial institutions, such as Bank of America and Standard Chartered, have also reduced their Chinese growth estimates.

What are the main reasons behind these downgrades?

1. Rapid Expansion in Credit

According to the statement issued by the IMF, the rapid expansion in credit in China is alarming since lending conditions are inefficient. In particular, the IMF pointed to the dominance of unregulated lenders, which are prone to default.

In line with this, credit rating agency Fitch recently issued a warning regarding the rise of “shadow banking system” in China, wherein the growing amount of credit issued by non-bank lenders results to lower transparency in the financial sector.

Poor transparency and the higher risk of default could put the Chinese central government in jeopardy if it ends up shouldering the costs of bankruptcy among financial institutions and non-bank lenders.

2. Structural Economic Problems

The IMF also highlighted the negative repercussions of income inequality and an investment-driven growth model. The institution warned that most of the investments have been concentrated in the housing sector, driving property prices much higher. This puts China at risk of an asset price bubble as average wages aren’t increasing at the same pace.

In addition, the wide gap between the rich and the poor is making China’s drive towards rebalancing its economy more challenging. Recall that China is trying to boost domestic activity in order to keep its economy afloat in the midst of weakening external demand.

3. Weak Demand

Another reason why the IMF and OECD cut China’s grades is the weak demand on both the international and domestic fronts.

Growth for Q1 2013 was undermined by the weaker demand from its two biggest export customers, which are the U.S. and the euro zone. However, it’s the weaker local demand that has the biggest drag on the economy. According to the OECD, the combination of weak inventory purchases and Beijing’s campaign against extravagant consumption doesn’t bode well for economic growth.

In addition, there are naysayers who think that lower factory production as well as dismal investment performance would carry on for some time. Yikes! Does this mean we should start worrying about China?

Both the OECD and the IMF think that the recent slowdown in economic growth is nothing more than just a minor road bump.

The OECD is hopeful that more efficient world trade would boost the economy in 2014 and allow the Asian superpower to print an 8.4% growth rate. Meanwhile, the IMF thinks that the worst could soon be over, as the organization projects a pick-up in credit as well as the global economy in the second half of 2013.

What do you think? Is China headed for a rebound or do you think the worst is still to come?