Chinese regulations tightening credit will leading to shrinking GDP growth on the mainland, according to BlackRock.

The country posted GDP growth of 7.7% in the first quarter and 7.5% in the second quarter, and the US fund house anticipates significant downside risk that could lead to a further slowdown in the second half of the year.

Andrew Swan, head of Asian fundamental equities at BlackRock, says GDP growth “really depends on what the government does”, but the firm expects China will tighten credit lending practices, which could mean a further GDP growth downgrade below the general consensus expectation of between 7.4% and 7.6%.

“I think we will continue to see GDP downgrade expectations for China in the next six to 12 months,” Swan says, noting that equity markets, which have been on a roller-coaster ride since late June when Shibor rates hit 13%, will continue to remain sluggish as a result.

Chinese companies have been producing goods against a backdrop of forecast GDP of 8%, so will inevitably face overcapacity issues as a result of slower growth, argues Swan. Corporate profits will suffer, asset quality at banks will deteriorate and the rate of non-performing loans will rise, he adds.

As such, BlackRock is underweight Chinese banks as well as cyclical stocks, but Swan declined to name specific companies.

However, he cites a few select opportunities, such as healthcare stocks (production costs on the mainland, such as for pharmaceuticals, are very low); internet-related companies (this sector is seeing strong earnings growth expectations) and leisure companies (which have benefited from increasing travel among mainland Chinese).

Yet getting the timing right on cyclical stocks is essential, and BlackRock will only consider them after overcapacity leads to consolidation. Once that happens, these companies will have more pricing power and dominance in the market, says Swan.

Meanwhile, BlackRock is also bearish on Chinese credit. Joel Kim, head of Asia Pacific fixed income, dislikes Chinese investment-grade credit, even quasi-sovereign issues (i.e., debt from a government-backed agency).

Kim’s fear is that the onshore deleveraging will lead to a credit crunch – indeed, there has already been weak lower-grade bond issuance.