China’s output hits top gear

China’s manufacturing index, considered the heartbeat of its economy, rose in August at its fastest pace in 16 months, reinforcing confidence around the world that a perceived recovery in the world’s third-largest economy may be for real.

The Shanghai stock market, however, ended only marginally up a day after its biggest fall in over a year, reflecting lingering concerns that new loan disbursals, which are on course to touch 10 trillion yuan ($1.5 trillion) this year, will contact sharply, impeding liquidity flows to the market.

The official Purchasing Manager’s Index of China rose to 54 in August from 53.3 in July, marking the sixth consecutive month above 50, the threshold that indicates economic expansion.

“Industrial activity should continue to grow in the coming months, driven by strength in domestic demand and a rebound in exports,” says JP Morgan chairman of China Equities Jing Ulrich. “The government’s economic stimulus programme has had a significant impact on domestic demand and China appears on course to achieve its growth target for the year.”

The policymaking State Information Centre recently forecast 8.5% GDP growth in the third quarter of 2009, well above 7.9% year on year in the second quarter and 6.1% in the first.

The PMI reading is “not too hot, not too cold,” says Andy Rothman, China macro strategist at CLSA. It supported the view that “while Beijing will continue to withdraw some of the stimulus that has done its job (lending and infrastructure spending) and is no longer needed, we will not see any measures designed to slow economic growth.” In other words, he adds, there won’t be any “tightening.”

“This is a set of good numbers in terms for growth prospects,” says Credit Suisse economist Dong Tao. The data suggests that “demand for infrastructure items still exists, even though the overall trend could still be plateauing.”

A sharp fall in new loan disbursals in July and the likelihood of another weak figure for August have raised fears of early tightening and its implications for growth and asset prices, but Tao says he is not “overly worried” about a drop in new loan growth. That’s because, he says, China’s monetary policy has shifted “from being quantity-focussed to quality-focussed, with the aim to minimise the side effect of loose liquidity conditions.”

Pointing to China’s “weak” exports sector and the “still fragile” labour market, Tao reasons that “until unemployment concerns —- and hence social stability concerns —- abate, we do not believe that Beijing will hit the brakes hard across the board.”
Ulrich too believes that China’s “moderately accommodative fiscal and monetary policy is likely to continue while the domestic recovery gains traction.” Overall, she adds, “we expect credit will remain abundant in the second half, though new lending will moderate in line with seasonal norms.”