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Outlook for China’s Economy Just Keeps Getting Worse

Thursday, 23 May 2013 | 12:47 AM ET
©Alan Nee | Flickr | Getty Images

The unexpected contraction in China's factory activity in May has heightened the risk of a further slowdown in the second quarter, after the world's second largest economy grew at its slowest pace in three years over January to March, said economists.

The flash HSBC Purchasing Manager's Index (PMI) for May that was released on Thursday slipped to 49.6, falling under the key 50 level, which divides expansion from contraction, for the first since October. Last month, the final HSBC PMI stood at 50.4. The decline was driven partly by a fall in new orders - with the sub-index dropping to 49.5, the lowest reading since September.

"It is not good and it does increase the chances of a sequential slowdown in the second quarter GDP [gross domestic product]. Simply put, domestic demand this time wasn't strong enough to counter fully the impact of still weak external demand," Donna Kwok, greater China economist at HSBC told CNBC on Thursday.

Asian markets took a hit following the release of the data, alongside the Australian dollar which fell to a fresh 11- month low against the greenback.

Shane Oliver, chief economist at AMP Capital said the latest PMI reading is a warning that the brief upswing in the world's second largest economy late last year has faded, adding that growth could dip below 7.5 percent this quarter from 7.7 percent in the first three months of the year.

"Momentum that had been starting to build late last year is now reversing. And a big chunk of that softness is in the manufacturing sector," Oliver said, noting that monetary conditions may not be easy enough to support growth in the mainland at the moment.

(Read More: China Growth May Hit 9% by Mid-2014)

Oliver, however, doesn't expect a dramatic slowdown in growth. "PMI is still at a level which has correlated with OK growth in China. I suspect you would have to get below 40 to signal a recession in China, we're a long way off from that," he said.

Nothing to Worry?

According to Dariusz Kowalczyk, senior economist at Credit Agricole, investors shouldn't worry too much as it is not uncommon for manufacturing PMI to be in negative territory.

"It stayed there for the first three quarters of last year, and despite that industrial production expanded," he said.

In addition, Kowalczyk argues that there is an element of seasonality in the decline. The PMI typically falls in May, he said, noting that in the past five years, the index has fallen four times by an average of 0.7 points in May. This month, it fell 0.8 points.

(Read More: China President Takes Charge of Sweeping Economic Reform Plans)

"We are keeping our growth forecasts for 8 percent for 2013. We expect a reacceleration in growth in the second quarter as the first quarter marked the end of destocking by manufacturers."

At 8 percent growth for 2013, Kowalczyk is among the most bullish on China's growth prospects.

A Wall Street Journal poll of 12 banks published last week showed of the major lenders, HSBC has the highest growth forecast for China at 8.2 percent for 2013, while Societe Generale, by contrast, has the most bearish view on the economy, projecting 7.4 percent growth this year. The median forecast was 7.8 percent.

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