The International Monetary Fund (IMF) has warned that the worsening debt crisis in the Euro zone poses a key risk to China's growth. IMF added that China also faces domestic risks, not least from a sharper-than-anticipated decline in the property market.
However, the fund said China had ample room and the fiscal tools to respond forcefully to any such developments.
Growth in China's economy slowed to a three-year low in the second quarter. Its economy expanded at an annualised rate of 7.6% in the three months to the end of June.
The fund said that it expects China's economy to grow by 8% in the current financial year, but warned that a lack of response to the deteriorating crisis in the Euro zone may cut that number by half.
The main external risk continues to be spill over to China from a worsening of the euro area crisis, the fund said.
Assuming no policy response in China, growth could decline by as much as four percentage points in response to a one and three quarter percentage point slowdown in global growth.
The Euro zone is a key market for Chinese exports and the fear is that if the debt crisis escalates it may dent consumer sentiment and demand, resulting in slowing exports to the region.
The fund said internal issues are also a threat to China's economic growth, including the country's property sector.
Chinese banks lent out record sums of money in the past few years in a bid to sustain growth amid the global financial crisis. That resulted in a boom in the country's property market.
However, there have been fears of asset bubbles being formed and of the impact of a crash in property prices on China's overall economy. As a result, Beijing has been trying to implement measures, in a bid to curb speculation and cool down growth in the sector.
The measures, which include a restriction in some cities on the number of homes an individual can own and higher down-payments for property purchases, have resulted in property prices falling in most Chinese cities.
However, the fund warned that a disorderly decline in real estate investment could have significant implications for growth in China.
Following a decline in real estate investment, activity would fall in a broad range of sectors, given the real estate industry's strong backward linkages to other domestic industries such as consumer durables, construction, light industry, electricity.
Among the other domestic risks, the fund said that Beijing needs to keep the local government debt in check, which has been a cause of concern for many analysts.
It added that policymakers need to put in place measures to closely monitor and control the risks related to borrowing by local entities, especially local government financing vehicles.
The fund also urged China to reduce its reliance on investment to boost growth and instead focus on domestic consumption in the country.