PMI contraction suggests China gasping for domestic stimulus & breakthrough in trade talks

(Image: Reuters)

Anubhav Sahu
Moneycontrol Research

Highlights:
- China PMI contraction has implications beyond domestic manufacturing
- Apple’s sales downgrade and Korea’s export numbers are a case in point
- Measures to boost consumption and liquidity may trickle down with a lag
- Weakness in global demand could negatively impact industrial profits
- Breakthrough in US-China trade talks could be the most anticipated growth boost
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Leading indicators for the Chinese economy continue to show weakness on both the export and domestic manufacturing front. The official December Purchasing Managers' Index (PMI) survey and the private Caixin PMI survey suggest contraction in manufacturing activity. The last such major phase of weakness was in mid-2016.

While part of the moderation in growth has been well anticipated due to the deleveraging cycle (includes clamping down on various non-banking sources of credit) and supply-side reforms (lower volume growth), weakness on the demand side has been more than anticipated and has implications beyond China’s borders. Apple’s downgrade of its sales outlook on January 2, and South Korea’s weak export data released earlier this week, are at least partially on account of weak domestic demand in China.

China PMI

Source: tradingeconomics.com

Demand scenario not firm

According to IHS Markit Economics, new orders have fallen for the first time since June 2016. The surveyed companies mentioned that weak market conditions have weighed on sales. Average input costs have fallen for the first time in the last one-and-a-half years, in tandem with a decline in oil prices. While this partially explains the sharp decline in output prices, it remains a key concern as output prices have declined for two consecutive months and points towards weak demand conditions.

China PMI  versus retail sales

Source: tradingeconomics.com

Measures to boost consumption and liquidity may trickle down with a lag

Recently, the Chinese authorities have tried to tweak personal income tax slabs to increase disposable income. At the same time, incentives for the SME sector have been targeted so that employee layoffs are avoided.

There has been talk of various incentives such as slashing sales and import tariffs. The Peoples Bank of China (the Chinese central bank) has already reduced its reserve rate requirements in recent times and hence made more funds available for funding at lower costs. More is expected on this front.

Export orders remain a pain point

The Markit survey shows new export orders have declined for the ninth consecutive month, a result of the ongoing US-China trade spats. While the trade balance contributes less than five percent to China GDP, it could have offset the domestic slowdown in Chinese manufacturing.

The Chinese authorities are expected to target a revival in consumption, improve the credit situation and offer a calibrated approach for reduction in debt so that growth in minimally hampered. However, it would take a while for domestic growth to show signs of improvement.

The other factor to watch out for is any softness in global growth.  China’s industrial profit cycle has largely been, aided by firming global demand and China's supply-side reforms. However, any weakness in global demand may moderate the profit trajectory further.

Finally, a breakthrough in US-China trade talks could be the most anticipated growth boost that Chinese authorities are eyeing.

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