June 1, 2010 / 5:10 AM / 9 years ago

China economy slows on tightening and seasonal factors

BEIJING (Reuters) - The pace of China’s factory output eased last month as gradual policy tightening took a toll on new orders, suggesting to some economists that Beijing will take its time before nudging interest rates higher.

Employees of Luen Thai, an apparel and fashion service provider, work at a production line in a factory in Dongguan, China's southern Guangdong province May 14,2010. REUTERS/Tyrone Siu

But a pair of surveys of manufacturing executives pointed to a loss of momentum, not a sudden stop, in the world’s third-largest economy, which is underpinned by rising incomes and vast infrastructure spending.

The purchasing managers’ index (PMI) issued by the China Federation of Logistics and Purchasing eased to 53.9 in May from 55.7 in April. That was close to the median forecast of 54.0 in a Reuters poll of 10 economists.

A companion index compiled by British research firm Markit for HSBC dropped to an 11-month low of 52.7 in May from a downwardly revised 55.2 in April.

“The slowdown in the headline manufacturing PMI suggests that the overheating risk is likely to ease as tightening measures filter through,” said Qu Hongbin, chief economist for China at HSBC.

Beijing has applied the brakes to money and credit growth and has rolled out a raft of measures to deter speculative buying in real estate.

The central bank has also raised the proportion of deposits that banks must hold in reserve, rather than lend out, three times this year.

But China has resisted international pressure to let the yuan rise and has kept benchmark interest rates unchanged despite an acceleration in year-on-year gross domestic product growth to 11.9 percent in the first quarter from 10.7 percent in the final quarter of 2009.

Qu said slowing growth, plus worries about the impact on Chinese exports of the European debt crisis, was likely to delay an increase in interest rates to next quarter.

Prime Minister Wen Jiabao, speaking in Tokyo, said on Monday that Chinese growth was on track but that it was too early for countries to consider withdrawing anti-crisis stimulus policies.

SLOWING MOMENTUM

The PMI indexes are closely watched because they give a timely snapshot of how industry is faring. An index reading over 50 denotes expansion; a sub-50 figure signals contraction.

The slower growth suggested by the PMIs weighed on share prices. The MSCI index of Asia Pacific ex-Japan stocks, which has been underperforming world equity markets so far this year, fell 0.93 percent.

Shanghai stocks ended the morning with a fall of just over 1 percent.

“The result indicates weakening of momentum in the manufacturing sector and confirms our expectation that GDP growth will slow sharply in Q2 and continue decelerating in Q3,” Dariusz Kowalczyk, chief investment strategist with SJS Markets in Hong Kong, said in a note.

But May’s reports reinforced the suspicions of some economists about the reliability of the surveys.

Goldman Sachs economists Yu Song and Helen Qiao noted that the official PMI has consistently fallen in May — when there is a long public holiday — since it was launched in 2005.

“After adjusting for this seasonality, the May reading was slightly higher than its April reading. Therefore, we would not view the softening in the headline PMI as a sign of much softer industrial growth in May,” they said in a note.

Zhang Liqun, a government economist, said it was tough to judge whether the decline was due solely to these seasonal factors.

“The fall may indicate the economy is slowing from its fast pace of growth,” he said in a comment issued by the logistics group.

The moderation in the indexes was broad-based. They indicated that the pace of output, new orders and employment all softened, while the prices paid by companies for their inputs rose less sharply.

But Qu with HSBC said money and credit growth was still excessive and would require further increases in banks’ required reserves and administrative lending curbs in coming months.

“China’s GDP growth should continue to cool off in the second half of 2010, which is a must to contain inflationary risk. Despite the property measures and uncertainties on exports, GDP growth is still likely to stay around 9 percent in the second half, thanks to continued investment into ongoing infrastructure projects and steady growth in wages and consumption,” he said in a note.

Reporting by Langi Chiang and Alan Wheatley; Editing by Ken Wills and Neil Fullick

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