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A tale of two China PMIs: Manufacturing still in contraction mode

China's all-important manufacturing sector remained in the doldrums during the month of September, according to two separate reports on Thursday.

The government's official gauge of factory activity improved with the manufacturing PMI rising to 49.8, up from August's three-year low of 49.7 but still marking two straight months of decline. Meanwhile, a private survey by Caixin/Markit revealed PMI fell to a fresh six-and-a-half year low of 47.2, ticking down from August's reading of 47.3 but still better than an earlier flash estimate of 47.

A reading below 50 indicates activity is shrinking on a monthly basis, while one above indicates expansion.

Unlike the government's gauge that concentrates on large firms, Caixin's survey focuses on smaller and medium-sized companies.

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Total new work fell at the quickest rate in over three years, partly driven by a steeper fall in new export business, Markit said in a report. As a result, companies cut output at the sharpest rate in six-and-a-half years, while staff numbers fell at the quickest pace since the start of 2009

Chinese financial markets were closed Thursday for the start of a week-long public holiday, but the rest of Asian indices traded higher following the two reports. Japanese and Australian shares led gains by more than 1 percent each, while the Australian dollar added 0.4 percent against the greenback.

In other surveys released on Thursday, the official services PMI for September came in at 53.4, unchanged from August, while Caixin's final report showed the services index slumping to a 14-month low of 50.5.

Shortly after the reports, Markit announced it will stop releasing monthly preliminary readings of manufacturing PMI, known as the flash estimate. It will continue to issue monthly Caixin China general manufacturing PMI and general services PMI.

Large vs small firms

The official PMI tends to print higher than Caixin's since it tracks large, state-owned enterprises (SOEs), which are benefiting from government stimulus and infrastructure investment, explained Julian Evans-Pritchard, China economist at Capital Economics.

A Chinese denim factory
STR | AFP | Getty Images
A Chinese denim factory

Indeed, several experts have pointed out that Beijing's monetary and fiscal stimulus throughout this year tend to be more favorable to SOEs since they have better access to bank loans than smaller, private enterprises. Moreover, officials unveiled plans for reforming SOEs earlier this month that include more public private partnership investment, a factor likely to boost those companies further.

In contrast, the concern is that smaller manufacturing firms are still struggling, Pritchard said.

"Going into the fourth quarter, Beijing is doing a lot for SOEs, but for the private sector, it seems to me there are very little things they could do," noted Hao Hong, chief strategist at Bank of Communications International.

Moreover, September's official report only surprised to the upside since previous readings in recent months have missed historical expectations, pointed out Donna Kwok, senior China economist at UBS.

Still, the majority of analysts agree that weak overall sentiment is weighing down manufacturing in both large and small firms.

A string of dismal economic indicators, such as August's 5.5 percent fall in exports and recent stock market volatility, have heightened concerns about the world's second-largest economy. As weakness in emerging markets increasingly gets blamed for global growth deceleration, International Monetary Chief (IMF) Christine Lagarde warned on Wednesday that Beijing must safeguard "demand and financial stability" and continue rebalancing its economy away from commodity-intensive investment.

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More stimulus on the cards

Thursday's dual readings fueled expectations for more monetary and fiscal support, such as additional interest rate cuts and lower bank reserve requirements.

"China's weak survey data suggest that additional policy easing is quite likely before year-end," explained Bill Adams, vice president and senior international economist for PNC Financial Services, in a note. "Emerging market central banks see an opening to leave monetary policy looser for longer in the Federal Reserve's decision in September to defer an initial interest rate hike until closer to year-end."

Furthermore, a look at China's currency reserves could also warrant more stimulus.

"The greater concern around China is towards the drawdown of its foreign exchange reserves to offset the outflows from its economy. This has created a tightening of financial conditions and we simply can't rule out further easing of the reserve ratio requirements or lending rates in the short-term," noted Chris Weston, IG's chief market strategist.

Reserves dropped by a stunning $94 billion in August, the largest monthly fall on record, as Beijing intervened in markets to stabilize the yuan and its stock markets.