China Manufacturing Picks Up, but Troubles Remain

Despite better-than-expected economic data out of China on Thursday that pointed to a pick up in domestic manufacturing activity, analysts warn the mainland economy continues to face serious headwinds, which would likely lead to further monetary easing.

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“(The PMI data) is a welcome sign, but it is just barely over 50. And don't forget that Europe is now China's largest trading partner so if it should implode, that is going to have a tremendous impact on China's exports,” Andrew Leung, Founder, Andrew Leung International Consultants told CNBC on Thursday.

China's official purchasing managers' index (PMI) for February rose to 51.0 from 50.5 in January. While, HSBC’s PMI edged up to 49.6, from 48.8 in the previous month, but still remained under the 50-point threshold demarcating expansion from contraction.  

Market reaction to the data was relatively muted, with the Shanghai Composite

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In addition to worries about a slowdown in exports, Leung points to the steep decline in local government-driven infrastructure investment and land sales, which he says is a more “severe” concern.

“Local credit has been severely squeezed in recent months and the property market has also been tightened, affecting land sales. The financial capacity of local authorities have become very constrained,” he said. “Investment in infrastructure by the local governments has dropped by 70 percent.”

Sun Junwei, China Economist at HSBC agrees that the mainland economy continues to face key risks that threaten its growth outlook.

“Investment growth is likely to slow further into the year, as signaled by the deceleration of January's import growth, lower-than-expected credit growth, and the cooling housing market,” Sun wrote in a research note.

“Despite the uptick in headline PMI, we still believe that the key risk is tilted towards growth,” he said.

PBOC Poised to Ease Policy Further

Given the economic uncertainties, five analysts polled by CNBC believe China’s central bank will continue to loosen monetary policy, primarily through reducing banks’ reserve requirement ratios (RRR).

The central bank eased policy by 50 basis points just two weeks ago, taking reserve requirements for large banks to 20.5 percent.

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Two of the analysts said they expected RRR cuts of another 100 basis points in the coming months. One of them, Dickie Wong, Executive Director at Kingston Securities said there was a lot of room for easing policy given that credit growth in the month of January was far less than expected.

Banks in China extended 738.1 billion yuan ($117 billion) of new loans last month, compared with the 1 trillion yuan median forecast by economists.

Vasu Menon, Vice President of Wealth Management at Singapore-based OCBC said China’s central bank was also likely to remain in easing mode because the Chinese government wants to avoid “negative surprises” in a year where the country will see an important leadership change.

“We see China slowing down from 9.2% last year to 8.5% this year, and they have to ease liquidity,” Menon added.