More government intervention is needed to prop up China's growth to avoid the country getting stuck with over-indebtedness and falling prices, says HSBC.
The British bank yesterday predicted that China will continue to slow down to about 6.7 per cent economic growth a year for the next two years, owing to a slump in global trade and a lack of domestic demand.
"The government's fiscal policy will have to play a bigger role," said HSBC economist John Zhu.
While some have said that a slowing China is a "new normal", Mr Zhu disagrees.
"It's unreasonable to expect the double-digit growth to continue," he said, adding that the current situation is more like China becoming "normal", growing at a more sustainable rate of around 7 per cent.
He said growth in the service sector has cushioned part of the slide in the manufacturing sector in the past one to two years. But the boost from the service sector is not enough to bring growth to its potential level.
Mr Zhu thinks that there is an urgent need for policymakers to step in to prevent falling prices from becoming entrenched. He pointed out that debt in China is largely concentrated in the corporate sector.
On the other hand, producers' prices have been steadily falling for the past four years, creating a big squeeze on corporate margins. If this is allowed to continue, China may end up in a protracted deflationary slump.
To avoid the scenario, policymakers could look to monetary easing to cut interest rates, as well as the required reserve ratio for the biggest banks, said Mr Zhu.
He forecasts cuts of 0.5 per cent for interest rates and 4 per cent for the required reserve ratio this year.
Many firms are still seeing opportunities in China, said Mr Tim Evans, HSBC regional head of mid-market enterprises. "The China economy is being transformed from a low-end manufacturing-based economy to one led by higher quality, value-add manufacturing and a growing services sector," he said.