Workers take a nap during lunch break at a Foxconn factory in the township of Longhua in Shenzhen, Guangdong province in this January 21, 2015 file photo. (Reuters Photo/Tyrone Siu)

China Factory Survey Dents Hopes of Early Economic Recovery

JULY 24, 2015

[Updated at 01:59 p.m. on Friday, June 24, 2015]

Beijing. China's factory sector contracted by the most in 15 months in July as shrinking orders depressed output, a preliminary private survey showed on Friday, a worse-than-expected result that comes on the heels of a stock market crash which began in June.

The flash Caixin/Markit China Manufacturing Purchasing Managers' Index (PMI) dropped to 48.2, the lowest reading since April last year and a fifth straight month below 50, the level which separates contraction from expansion.

Economists polled by Reuters had forecast a reading of 49.7, slightly stronger than June's final reading of 49.4.

Output in July was 47.3, its lowest since March 2014. New orders and new export orders, both of which expanded in June, fell this month, according to the survey, while prices of outputs and inputs tumbled.

"Today's PMI reading suggests that recent improvements in economic momentum may have been derailed this month by weaker foreign demand," Julian Evans-Pritchard, China Economist for Capital Economics in Singapore, wrote in a note.

In fact, all the major survey indicators were downbeat except for employment, which was slightly stronger than in June but still showed a contraction.

"Given the survey-based nature of the PMI, it cannot be ruled out that today's number may have been disproportionately impacted by the weakened sentiment following the equity market correction since June," HSBC economists Qu Hongbin and Julia Wang wrote.

Contrasting pictures

The poor PMI results contrasted with June data, much of which surprised on the upside and suggested that the world's second-largest economy was stabilizing more quickly than expected. China reported annual growth of 7.0 percent in the second quarter, slightly above economists' expectations.

But there were wide doubts about whether there could be a sustainable recovery.

For one thing, the June indicators largely reflected economic conditions before a massive stock market crash wiped out trillions of dollars of market capitalisation on Chinese exchanges, forcing the central bank to adapt its monetary policy and causing Beijing to roll out a massive policy support package to get indexes to stop plummeting.

Some economists had warned that the crash could have a wider impact on corporate performance and confidence, given some companies had derived a substantial chunk of their profits from investment income as opposed to core business activity. Also, there were worries many had borrowed heavily to play stocks.

"Recent signs of economic stability were mainly the result of a rebound in infrastructure investment and the real estate market, but it's hard to judge if the rebound is sustainable or not," said Hu Jiani, analyst at Cinda Securities in Beijing.

More easing ahead? 

The continuing factory output contraction seen in Friday's survey is likely to fuel speculation that China will accelerate the pace of loosening monetary policy to try to stoke activity.

Economists polled by Reuters this month said they expect China to reduce interest rates by 25 basis points before the year-end. The amount of cash that Chinese banks must hold as reserves was also expected to be reduced to keep the Chinese economy growing at 7 percent this year, the slowest pace in a quarter of a century.

Additional policy support would make it the most aggressive easing cycle overseen by the central bank since the height of the 2008/09 global financial crisis.

"The central bank will maintain its loose monetary policy in the second half this year, and it will continue to apply different methods to control liquidity," Zhu Haibin, economist at JP Morgan in Beijing, said on Wednesday.

Domestic market reaction to Friday's survey was muted, with stocks rising slightly in the morning session, while the spot yuan remained docile.

But the survey pulled down other Asian stock markets as well as some commodity prices.