China Manufacturing Bounce Doesn’t Rule Out Stimulus

While a key private sector indicator shows Chinese factory activity picked up in July, experts tell CNBC economic conditions in the mainland still remain fragile and expect policymakers to provide further stimulus in the coming months.

Labors work at a clothing factory on August 1, 2011 in Huaibei, Anhui Province of China.
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Labors work at a clothing factory on August 1, 2011 in Huaibei, Anhui Province of China.

The HSBC Flash Purchasing Managers Index (PMI) - the earliest available indicator of manufacturing activity in China - rose to five-month high of 49.5 in July from 48.2 in June, driven by an increase in the pace of manufacturing output.

A reading above 50 indicates expanding activity and one below 50 signals contraction.

“With a reading still under the critical 50 line, it is clear there remains much downside pressure in the Chinese economy,” Alistair Thornton, China Economist at Global Economics Group, told CNBC after the release of the data Tuesday.

“Manufacturing activity has contracted every month since October last year, painting a picture of stressed corporate profitability and a weak external climate. The economy has yet to turn,” Thornton added.

Hongbin Qu, Chief Economist, China & Co-Head of Asian Economic Research at HSBC, agrees that the slowdown in manufacturing activity has yet to be fully reversed, pointing to the employment sub-index, which fell to 47.4 in July - compared with 48.8 in June – its lowest level since March 2009.

“The job market is coming under increasing pressure….(and) the small improvement in new orders implies there is no meaningful turn around in domestic demand just yet,” he added. The new orders sub-index rose to 48.9 in July compared with 47.2 in June.

Qu says policymakers need to step up policy easing to support growth in the form of both monetary and fiscal stimulus.

Jian Chang, a Hong Kong-based economist at Barclays, says she expects China's central bank to cut banks’ reserve requirement ratio (RRR) and interest rates this quarter as economic growth is unlikely to dramatically pick up after bottoming in the second quarter.

“The People’s Bank of China may not want to cut interest rates because of the inflation risk, but my feeling is that they may be forced to act because of the external situation and slowing exports,” Chang said.

She forecasts the central bank will cut the benchmark lending rate by 25 basis points by September, adding that a 50 basis point RRR cut could take place as early as this month.

Markets Feel Some Relief

PK Basu, Managing Director and Head of Asia Research & Economics at Maybank Kim Eng, who is more upbeat about the rise in the HSBC Flash PMI for July, says the data mark a "turnaround" in the Chinese economy.

“This is the strongest (reading) in five months. We’ve had two significant rate cuts and clearly the impact of the rate cuts is beginning to come through,” Basu said.

Relief over an improvement in the mainland manufacturing data sent some risk assets in Asia higher in the afternoon session, including the Australian dollar and cyclical markets such as South Korea’s KOSPI and Singapore’s STI Index .

By CNBC’s Ansuya Harjani