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Why manufacturing PMI still matters for China

Zhang Peng | LightRocket | Getty Images

Come Thursday, markets will be digesting a new round of manufacturing data from China, when HSBC releases the flash estimate of the Purchasing Manager's Index (PMI) for August.

It's a reading investors and analysts pay close attention to every month for a pulse check on the world's second-largest economy, never mind that it's infamously volatile or the fact that the figure will hold less credence as China re-balances away from a focus on the heavy industries towards domestic consumption.

Liu Li Gang, chief China economist at ANZ, who expects this month's PMI to come in at 51.3, a tad lower than the 18-month high of 51.7 recorded in July, says like it or not, the PMIs will continue to move Chinese markets in a way few other indicators can.

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For a country where credibility of data often invokes skepticism, these PMIs serve as good counterpoints to China's data deluge every month.

"It is a good leading indicator, markets tend to pay attention because it is a private survey that focuses on China's small and medium sized companies; an important segment of the country's manufacturing industry," he said.

Together with the China official manufacturing PMI, which includes surveys of big state-owned firms, the indicator could flag if Beijing's stimulus released earlier this year was enough to keep the country's economy buzzing, or if more easing is necessary, Liu added.

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But hanging the hat solely on China's manufacturing surveys is not enough, analysts say. With domestic consumption becoming a key driver of growth, Dariusz Kowalczyk, senior economist and strategist at Credit Agricole, says the services PMI readings will start to have bigger sway.

Last year, the services sector made up about 46 percent to China's GDP, overtaking the manufacturing sector's contribution of 44 percent.

"The services PMI is important because the sector represents the largest segment of the Chinese economy, so what happens with services will have significant impact on China's GDP," said Kowalczyk.

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Besides clues on new business expectations which give a gauge of demand for the services industry, services PMIs also tracks the real estate market, and is valuable leading indicator on expectations in the sector, he added.

To be sure, there is still debate over which PMI to prioritize. Liu of ANZ says manufacturing surveys still trump their services counterparts, because there remains no clear trend that China's transition towards a service-based economy will overtake the importance of factory activity to the economy.

Louis Kuijs, China economist at RBS, agrees with Liu, questioning the credibility of services PMI in telling the China story. "In my opinion, the non-manufacturing PMI doesn't correlate much with the services industry, because it does not track sentiment in restaurant, travel, insurance and e-commerce sector. It mostly tracks services catering to the manufacturing industry such as logistics and trade-related insurance, which is not indicative of China's real services economy."

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While Kowalczak supports a focus on the services PMI, he concedes that the manufacturing readings can be "more telling. That's because "the manufacturing sector fluctuates more than services industry, and hence they are a better gauge of China's overall growth momentum in the short-term," he said.

Beyond the headline figure, sub-indexes such as new orders and prices do give a clearer indication of China's growth picture, Kowalczak adds. "Information (from sub-indexes) such as employment and inventories do provide color, but it's the new orders that tell the key story because it reflects the industry's demand outlook," he noted.

Still, wading through Chinese economic data can be daunting, especially when accuracy is frequently challenged by market watchers. Some analysts advise against fixating over small decimal moves; rather, investors should focus on readings that impact decisions by Chinese policy-makers, which aren't necessarily PMIs.

"For me, the most important readings are the monthly industrial production, fixed asset investments and electricity utilization," said RBS' Kuijs. "Why? Because that's probably the data that Chinese policymakers respond to when they formulate their growth plans," he said.