Corrected China resets for next chapter

HSBC's flash China manufacturing Purchasing Managers' Index has provided the first tentative signs that the increasingly intense efforts by China's authorities to arrest the slowdown in their economy may be starting to get some traction.

Coming a week before the official PMI numbers are released, the HSBC index provides an early indication of manufacturing sector conditions in China. In July the index was at a five-month high, rising from 48.2 in June to 49.5.

While an index reading of anything below 50 says the rate of growth in the sector is still falling, the latest result would suggest that the rate of that contraction has slowed significantly. HSBC's chief economist, China, Hongbin Qu, said the result implied demand was still weak and employment was under increasing pressure.

In recent months the Chinese authorities have acted with increasing urgency in response to the faster-than-anticipated slowing of the economy, with GDP growth in the June quarter slowing to a (by China's standards) meagre 7.6 per cent.

As it has become apparent that last year's crackdown on a residential property bubble, the continuing crisis in Europe and the faltering recovery in the US had combined to depress China's growth rate, the authorities have cut lending rates (twice), widened the window for their banks to discount that rate, lowered bank reserve ratios, encouraged more infrastructure spending and provided some incentives for more private investment.

They would have been comforted in embarking on their controlled efforts to stimulate the economy by an inflation rate that has been falling steadily and which is now at non-threatening levels.

The HSBC index suggests that, while the measures taken so far are starting to have some impact, there is scope for the authorities to do more, although no one expects them to embark on the kind of massive stimulus packages China deployed during the worst of the financial crisis – unless Europe implodes.

Reserve Bank Governor Glenn Stevens referred to the PMIs in a speech today and put the slowdown into perspective.

‘'Properly calibrated….they suggest that growth in China's industrial production has been running at about five percentage points below average, which means it is just under 10 per cent of GDP,'' he said.

‘'But it is a long way from a contraction. We did actually see Chinese PMI contract for several months in 2008. We are not seeing that at present."

Stevens later said that he regarded the slowdown in China's growth rate over the past year as a ‘'normal cyclical slowing'' rather than a sudden slump like that in 2008 and said the data was consistent with GDP growth of around 7 or 8 per cent.

While that was a significant "moderation" from the 10 per cent-plus growth rates over the past five to seven years, not even China could grow that fast indefinitely and there were clearly problems building from that earlier pace of growth in the form of rising inflation, over-heating property markets and probably a good deal of poor lending.

‘'It is far better, in fact, that the moderation occur if that increases the sustainability of future expansion,'' he said.

The slowdown, and what appears to be a lowering of China's target for GDP growth to around or just under 8 per cent, obviously has implications for Australia's resources sector and, indeed, has already had an impact. Most of the key commodity prices have fallen around 30 per cent this year, although they remain relatively high by historical standards.

As Stevens said, however, it is better to be exposed to China's business cycles and growth which by its standards is lower than in the recent past than to the what is likely to be, at best, prolonged periods of very low levels of growth, if any, in Europe and perhaps also in the US.

Both the European and US economies have some very significant and complex issues of debts and deficits to confront which will constrain their growth for a long time.

If the Chinese do manage a ‘'soft'' landing it will probably put a floor under commodity prices in the near term with the future of commodity prices then dependent on the extent to which the supply-side response to the pre-crisis surge in China's demand, a response that was delayed by the crisis, actually makes it into the market.