China: Drop In HSBC PMI Suggests Renewed Weakness

China’s HSBC Manufacturing PMI in November dropped markedly from 51.0 to 48.1, suggesting renewed weakness in the Chinese economy. The weakness appears to have driven mainly domestic demand. There is no evidence that the weakness is due to weaker exports in the wake of the European debt crisis, as export orders held up well in November.

The weak HSBC manufacturing PMI puts into question our expectation of a slight improvement in GDP growth in the current quarter. Monetary policy is already moving in a more growth supportive direction in China and today’s PMI indicates the policy response could be more forceful in the coming months. We expect the Peoples Bank of China (PBoC) to cut the reserve requirement ratio in early January. We still expect growth to recover in the coming quarters supported by lower inflation and a shift toward a more growth supportive policy, but today’s weak PMI suggests downside risk.

Details

According to the Flash estimate HSBC manufacturing PMI in November dropped sharply to 48.1 (Danske Bank: 51.7) from 51.0 in October. New orders dropped significantly from 52.7 to 45.7. This is the lowest level for the new order component since March 2009 and the first drop in the new order components for four months.

The weakness in the HSBC PMI appears to have been largely driven by weaker domestic demand, because new export orders held up quite well, increasing slightly to from 52.0 to 52.3. Hence, there is no evidence that the weakness in November has been driven by weaker exports in the wake of the European debt crisis.

The output price component plunged from 54.6 to 44.8 underscoring that inflation in
China is going to drop sharply in the coming months.

Assessment and outlook

The sudden weakness in the Manufacturing PMI is a surprise and suggests that there
could be considerable downside risk on our GDP forecast for Q4 11 and possible also for Q1 12. As seen in the chart the current level of the HSBC manufacturing PMI suggests GDP growth in the 6-7% q/q AR range in Q4, or broadly similar to GDP growth in Q3. Our current forecast for GDP growth in Q4 is 8.6% q/q AR, so today’s weak PMI puts into question our expectations of some improvement in GDP in the current quarter.

To be honest we are surprised by the apparent sudden weakness in domestic demand in November and the most likely explanation is the lagged impact from earlier monetary tightening possible through the property market. As stressed above there are no evidence that the weakness has any relations to the European debt crisis and weaker exports.

Nonetheless we maintain our view that it will be a soft landing of the Chinese economy and the economy will recover in the coming quarters. If it turns out that the economy has failed to improve in Q4 and possible even deteriorate further, then we expect the policy response to become stronger in the coming months. China in our view is already moving in the direction of a more growth supportive policy by selective easing of some credit restrictions. We expect the Peoples’ Bank of China (PBoC) to cut the reserve requirement for commercial banks in January and the PBoC yesterday actually made a selective cut in the reserve requirement for a number of smaller agricultural cooperatives. For the currency the implications are that the pace of appreciation against the US dollar will slow to around.