Published: Monday, 3 Aug 2009 | 12:56 AM ET

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A surge in domestic investment spurred factory activity in China and offset anemic exports, pushing a key gauge of the country's manufacturing sector to a one-year high.

Elizabeth Dalziel / AP

Brokerage CLSA's China Purchasing Managers' Index (PMI) rose in July to 52.8 from 51.8 in June, the fourth month in a row that the index, designed to provide a timely snapshot of manufacturing conditions, has been in expansionary territory above the watershed mark of 50.

The survey pointed to growing price pressures alongside the accelerated recovery, shedding light on why the Chinese central bank has begun to tweak monetary policy to keep credit growth from spiraling out of control.

But persistently sluggish global demand also illustrates its dilemma, with Beijing unwilling to tighten policy substantially until the job-rich export sector gets back on its feet.

The CLSA findings dovetailed with those of China's official PMI, released on Saturday, which rose for a fifth straight month in July despite a usual summer lull in the economy.

"Manufacturing activity continues to accelerate and, importantly, orders growth is being driven by the domestic economy," said Eric Fishwick, head of economic research at CLSA. "This is a positive as Chinese exports are now underperforming those of the north Asian newly industrialized economies, supporting the panel's description of export demand as 'lackluster'," he said.

Output growth and order books both hit 14-month highs in July, providing indications that the flow of new work was improving and giving manufacturers reason to expect sustained recovery momentum. Those highs contrasted with sluggish demand abroad, as export orders grew at a slower pace than in the previous month.
     
Bouncing Back

The seasonally adjusted PMI index stood below the break-even mark of 50 between August 2008 and March this year after the global financial crisis decimated exports and monetary tightening weighed on Chinese industry.

Beijing responded with a massive 4 trillion yuan ($585 billion) stimulus program and ultra-loose monetary policy, prodding its banks to unleash a flood of lending.

Monday's report showed that this pump-priming has breathed life back into the Chinese manufacturing sector and has been all the more vital with exports still flat. The PMI has risen by over 10 index points since the start of the year.

Another sign of the upward trajectory came in the first increase in prices charged by companies in 11 months, as stronger demand boosted their pricing power, CLSA said.

The sub-index for output prices jumped to 54.9 in July from 49.0 in June, illustrating why the Chinese central bank said last week that consumer prices could start rising again in the fourth quarter after being in mild deflation since February.

The focus for now, though, is squarely on the consolidation of the recovery in China's manufacturing sector. Although the official PMI only inched up to 53.3 in July from 53.2 in June, several economists said the performance was impressive.

"The index held steady even though activity typically slows down somewhat in the middle of summer," Ken Peng, an economist with Citigroup in Beijing, said in a research note. "The PMI, at these levels, points to further pick up in industrial production," he said.

It was the first time since 2005 that the official PMI had registered an increase from June to July, according to Merrill Lynch, a sign of the strength of the manufacturing revival.
     
Bullish

A breakdown of CLSA's PMI highlighted some of the more bullish trends in China, the world's third-largest economy.

New order growth was faster than the historical average of the series. Stronger incoming orders also pushed work backlogs to a 13-month high, with 15 percent of firms reporting an expansion of unfinished business since June.

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And manufacturing employment was up for the second straight month. Although the rise was modest, it still made July the strongest month for job creation since May 2008.

Chinese leaders have in the past two weeks repeatedly pledged to maintain an "active fiscal policy and moderately loose monetary policy" until the recovery is on firmer ground.

But officials have also expressed concern about the risk of stock and property bubbles inflating because of an unprecedented surge in bank lending, putting investors on watch for moves to tighten monetary policy as the recovery gathers pace.

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