Trade war’s ‘bigger than imagined’ shock and China’s economic slowdown weigh on small factories

Sidney Leng

Despite a small pickup in output and export orders, the outlook for small, private manufacturers in China is overshadowed by a slowing economy and a “bigger than imagined” shock from the US trade war, economists said.

A survey of Chinese factories showed weaker activity in December than November, despite the US and China reaching a trade war truce that averted new tariffs in the last month of the decade.

The Caixin manufacturing purchasing managers’ index (PMI), which polls small private sector factory owners in China, fell for the first time in five months to 51.5 in December from 51.8 in November, according to data released on Thursday. This was also below forecasts.

Anything above 50 shows that the sector remains in growth, and December’s decline comes on the back of a three-year high in November and four months of consecutive gains.

“Subdued business confidence was a major factor behind the economic slowdown this year. As the phase one trade deal between China and the US has sent out positive signals, there is room for a recovery in business confidence, which should be able to help stabilise the economy,” said Zhong Zhengsheng, director of macroeconomic analysis at CEBM Group, a financial research firm.

The growth came mainly from a strong rise in production, but the growth in new orders softened to a three-month low, despite the phase one trade deal being announced on December 13. Meanwhile rising operating expenses, including more expensive raw materials, dissuaded manufacturers from recruiting more workers.

The year-end Caixin PMI comes on the heels of the official survey, measuring large and state-owned manufacturers, which was weaker in comparison at 50.2, unchanged from November.

“The manufacturing PMIs ended 2019 higher than where they started the year, but we doubt this means the worst is over for China’s economy. While it does appear that export growth is bottoming out, downside risks to domestic demand, especially from the property sector, still cloud the outlook,” Julian Evans-Pritchard, senior China economist at Capital Economics, said in a note.

There were some positives to be gleaned for the sector. The export order components of both the official and Caixin PMIs are growing simultaneously for the first time since before the trade war kicked off in July 2018 – perhaps related to the truce.

Another potential green shoot was a recovery in South Korea’s shipments to China in December, much of which are intermediary goods for China to assemble into finished products for export, said Evans-Pritchard. Data from the Korea Customs Service, released on Wednesday, showed that Korean exports to China grew by 3.28 per cent last month from a year earlier, the first growth since October 2018.

However, despite the ceasefire, the residual impact of the tariff war may be worse than initially thought, particularly for export-oriented coastal and eastern provinces – such as Jiangsu, Zhejiang, Shanghai, Fujian, and Guangdong – the biggest contributors to China’s central government coffers, and the genesis of financial support for less developed regions.

“The trade tension between the US and China has been a bigger shock than we imagined,” said Yu Xiaohua, a researcher at Yangtze IDEI, a think tank from Nanjing University. “The biggest shock is to those coastal provinces that have fiscal surpluses, challenging their economic growth.”

Thedip in the Caixin manufacturing PMI still points to weakness in domestic growth momentum. We expect the manufacturing PMIs to weaken in coming months

Lu Ting, Nomura

The PMIs did not convince Lu Ting, China economist from Japanese bank Nomura, that the economy had not yet bottomed out. Nomura maintained its growth forecast of 5.7 per cent for this year, given headwinds from the cooling property sector and the worsening fiscal situation.

“Although the stabilisation of the official manufacturing PMI in December looks positive for markets, the dip in the Caixin manufacturing PMI still points to weakness in domestic growth momentum. We expect the manufacturing PMIs to weaken in coming months,” Lu said. “We expect Beijing to roll out more easing measures in the coming quarters, despite limited policy room.”

The Caixin PMI was released a day after the People’s Bank of China announced a modest easing by cutting required reserve ratio (RRR) by 50 basis points for all banks from next Monday. This was viewed as a move to support the economy, particularly private industrial firms that have struggled to access financing in the past year.

The move was within the expectations of many economists, who believed the central bank would further cut the RRR, along with other interest rates.

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