HSBC plays down drop in China PMI to 16-month low

Chinese manufacturing shrank on the month in July for the first time since the global downturn in March 2009 as government steps to slow bank lending and fight property speculation hit home.

An index based on a nationwide survey of business executives conducted for HSBC dropped to 49.4 from 50.4 in June.

The Purchasing Mangers' Index is designed to be a leading indicator of conditions across a wide range of industries.

A figure above 50 denotes expansion, but HSBC played down the drop, which coincides with spreading signs of weakness in the United States.

Although the index pointed to a month-on-month contraction in manufacturing, it was still consistent with annual growth in Chinese industrial production of 11-13%, HSBC said.

"We still expect the economy to grow by around 9% in the second half of 2010 and 2011, driven by resilient private consumption and continued investment demands of ongoing infrastructure and new public housing construction projects," HSBC economists Qu Hongbin and Sun Junwei said in a note.

The PMI is derived from a series of "qualitative" questions, not hard quantitative data. Executives are asked whether output, orders and jobs were stronger than the month before.

As a result, Qu and Sun explained, marginal changes of 1 or 2 points cannot be taken as a clear indication of an absolute improvement or deterioration of conditions, especially when the index is close to the neutral threshold of 50.

Financial markets took the drop in the PMI in stride.

The Japanese yen and Australian dollar barely budged, while an index of Asian stocks outside Japan edged up following the report.

Investors were relieved that a companion PMI, produced for China's National Bureau of Statistics and released on Sunday, held firmly above the 50 mark.

The closely watched index did fall, however, to a 17-month low of 51.2 in July from 52.1 in June.

The drop in HSBC's PMI, which prolongs a cooling trend that set in at the start of 2010, was led by the second successive drop in output and new orders.

The decline had echoes of a fall below 50 in August 2008 ahead of the bankruptcy of investment bank Lehman Brothers, which plunged the world financial system into chaos and ushered in the deepest global downturn in 80 years.

But conditions today are noticeably brighter, HSBC argued.

"The global economy is heading for a recovery (albeit a slow one), which should help avert a total collapse in exports. Moreover, the domestic engine hums on," Qu and Sun said.

Continued implementation of the 4 trillion yuan ($585 billion) stimulus plan announced in November 2008, plus the impending acceleration of public housing construction, should keep propping up domestic demand, they said.

Other analysts were also sanguine, seeing signs in the PMI reports that the economy is levelling off after losing momentum since the start of the year.

"If you look at the monthly changes, you can see that the HSBC PMI fell 2.5 points in May, 2.3 points in June and 1.0 point in July, which clearly shows that the economy is stabilising," said He Yifeng, an analyst with Hongyuan Securities in Beijing.

A further moderation cannot be ruled out due to uncertainties over Beijing's macroeconomic policy stance. "But it should be safe to say that there will be no sharp slowdown or big drop in economic activity," he said.

Mingchun Sun with Nomura in Hong Kong said that unless devastating floods continue this month, the next official PMI is more likely to show a rise than it is a fall.

"Considering the heavy flooding around the country, we believe the July PMI print should be viewed as better than its headline values," he said.