The central government will face intense pressure to revalue the yuan downwards, not up, against the US dollar within a year or two.

That is the surprising conclusion of Eddie Wong, ABN Amro chief Asian strategist, at a time when the widely accepted view that the yuan is undervalued lies at the heart of Sino-United States trade tensions.

The unconventional prediction hinges on the premise that China's economy cannot escape the consequences of a short-sighted investment binge based solely on growth.

Profits of mainland firms - ranging from those producing building materials to consumer durables - are being squeezed by higher input costs, such as for raw materials and skilled labour, and by cutthroat competition stemming from gross industrial overcapacities.

Of the 17 H-share companies that reported first quarter results, 12 saw a drop in gross profit margins. Among the worst affected was China's largest cement company, Anhui Conch, which experienced a year-on-year 95.1 per cent drop in net profit in the first quarter. The country's largest chemical fibre producer, Yizheng Chemical, suffered a 97.5 per cent drop.

For many China-focused economists, the figures herald the imminent arrival of a downward cycle in the world's fastest growing economy.

Mr Wong points out that investment already makes up more than half of China's gross domestic product and the proportion is rising. Figures for the first quarter put fixed asset investment growth at 25.7 per cent, despite a 16 per cent full-year target set by Premier Wen Jiabao.

The question is: where will demand for the excess cement, high-end flats and consumer electronics generated by over-investment come from?

Although most mainland industries already suffer from overcapacity, corporations are continuing their unabated building of excess capacity, assuming it will be their competitors - and not them - who will lose out in the race to grab market share.

In a recent research report, Vincent Chan, Credit Suisse First Boston's head of China research, argued that as overcapacity, cutthroat competition and rising input costs decimate profits, the effects will be compounded all the way to the banks.

The number of companies that can no longer service their debt to banks is likely to multiply, worsening non-performing loan ratios in a system still dealing with mountains of bad debt from the last economic downturn in the late 1990s. One critical difference is that private companies make up a much larger proportion of the economic mix.

Unlike the last downturn, when most of the economy was in state hands, corporations today do not have implicit guarantees from the government to ensure their survival.

According to Mr Wong, the sustained build-up of new problem loans would see the government faced with a choice - to allow the economy to follow course and experience a hard landing, or instruct the banks to keep on lending in the hopes that mainland firms will somehow find a way out - perhaps by exporting excess capacity to the rest of the world.

For banks to keep lending, they will need to be recapitalised. But by this point, Mr Wong estimates US$250 billion to US$300 billion in "hot money" that has flowed into China on bets of a yuan appreciation will be flowing out again.

Under such circumstances, the conventional wisdom could shift back to where it was as recently as early 2002, when the general consensus held that the yuan was overvalued by as much as 40 per cent.

China's long-term economic prospects are still positive but predictions from senior economists increasingly point to an imminent slowdown in the mainland's incredible growth.

Morgan Stanley economist Andy Xie, known for his bearish views on China, said: "Next year will probably be bad and the year after could very well be worse."