Given its high level of debt and tendency to fund large-scale infrastructure projects, China may find the trade war putting a significant damper on its efforts to deleverage. Overly optimistic estimates about the impact of the trade war on China's economy have not taken into account how tariffs will affect business sentiment, investment, and growth, according to a note from J.P. Morgan analysts.

China's economy expanded by a slower-than-expected 6.7% in the second quarter, and June factory output growth weakened to a two-year low as the trade dispute with the United States intensified. The yuan hit a one-year low on Thursday.

Indirect effects of the trade war could lead to "large" collateral damage.

Analysts in the People's Bank of China called for an adjustment to fiscal policy and some loosening of financial regulations, saying monetary policy couldn't resolve corporate funding challenges on its own. The regulatory tightening has pushed up corporate borrowing costs, prompting the PBOC to cut banks' reserve requirement ratios (RRR) three times this year.

As China's economic growth slows, debate on whether fiscal policy should help to soften the impact of a trade war with the United States has been ongoing. Both countries have already imposed tit-for-tat tariffs on each other's goods and with no signs of easing in tensions, Beijing has already started to loosen monetary conditions.

"All this puts China in a very difficult position. Not only because much of the tariff and non-tariff measures are directed towards it, but the timing couldn't have been worse," the JPM note said. "After years of handwringing and navel gazing, China finally began to focus in earnest on curbing credit growth - its Achilles's heel - from around mid-2017."

China's banks extended a record 1.88 trillion in loans in 2016 as the government encouraged credit-fueled stimulus to meet its economic growth target. The credit explosion stoked worries about financial risks from a rapid buildup in debt, which authorities in 2017 said they would contain.

New fiscal policy measures could entail increasing tax rebates - known as the value-added tax credit rate - to exporters in China, which would increase their income by between 3.5 % and 4%. A key development is the increased focus on small- and medium-sized enterprises (SMEs), which account for 80% of all jobs in China, and have suffered from rising borrowing costs and a shrinking credit pool amid Beijing's three-year-long crackdown on off-balance sheet financing and a corporate debt build-up.

"Relying more on fiscal policy to support domestic demand and defray the costs of the trade war is the wiser choice...Lessening the burden on monetary policy will also lighten the pressures on the currency," analysts said. They added, however, that the government could be held back by fears that easing caps on government spending could again accrue debt.