China PMI slump will test authorities’ resolve

July 30, 2016

By Rajeshni Naidu-Ghelani, CNBC

Further weakness in China's vast manufacturing sector, which has exacerbated concerns over the health of the world's second biggest economy, will make it harder for the government to resist calls to ease its policy stance, economists tell CNBC.

The flash HSBC Purchasing Managers' Index (PMI), an early indicator of Chinese factory activity, fell to 48.3 in June from a final reading of 49.2 in May, moving even further away from the 50 mark, which separates expansion from contraction.

Louis Kuijs, chief China economist at RBS, said the weakness is quite broad-based with a dramatic fall in new export orders, which also reflects domestic weakness.

"This sluggishness will test the resolve of the government as it tries to maintain its macroeconomic policy stance, because senior leaders have recently reconfirmed the paradigm of reform over stimulus, but if we in the coming months get more indication of growth slowing down further, then that resolve, that stance, will be tested," Kuijs said on Thursday.

Alistair Chan, economist at Moody's Analytics backed that sentiment, saying the manufacturing sector is still suffering from weak global growth and a lack of stimulus, which points to slower economic growth in the second quarter.

"We expect second quarter GDP (gross domestic product) to be another deceleration, possibly to 7.3 percent year on year down from 7.7 percent in the first quarter," Chan said. "If conditions deteriorate further in the third quarter, the government may be compelled to cut interest rates, but it is resisting doing so for now."

Rob Subbaraman, chief Asia economist at Nomura said the large drop in new export orders in particular, was more of a concern, highlighting that global growth is not that strong.

"China is one of the world's biggest manufacturers – it's a sign that China's economy is continuing to slow down and it does create more challenges for policymakers," Subbaraman said.

New export orders in June dropped to the lowest reading in 10 months of 47.1, suggesting weakening demand from overseas and within China.

Kuijs of RBS said that he had been hoping for better data from China on growth picking up in the U.S., Europe and the rest of the world, but that's clearly not materializing.

"We have a weak export picture, we also have a pretty tame domestic demand picture, so something is necessary to kick start growth," Kuijs said. "It may mean the weakness is going to spill over further into rest of the year."

Deepening Slowdown

China's weaker manufacturing data comes on the back of series economic data in the past month pointing to a deepening slowdown, with producer prices in May falling nearly 3 percent from a year earlier as deflation persisted for 15 straight months.

Fears of a hard landing have also been heightened by several major banks and international agencies downgrading their economic growth forecast for China in 2013. HSBC was the latest bank to join the trend, revising its GDP growth forecast just before the release of the PMI data, to 7.4 percent in 2013 and 2014, from 8.2 percent and 8.4 percent respectively.

Dariusz Kowalczyk, senior economist, Asia ex-Japan at Credit Agricole adds that it's time for China to ease and he expects the central bank to change monetary conditions shortly.

"We see either a RRR (reserve requirement ratio) cut or large-scale liquidity-boosting open market operations. We also expect depreciation of the yuan REER (real effective exchange rate) by a weakening of yuan fixing against the US dollar," Kowalczyk said in a note.