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Wednesday, April 01, 2009

Manufacturing Industry Contracts Again In March (Update 2)

China’s manufacturing industry shrank for an eighth straight month in March as collapsing global trade cut exports and growth across Asia. The CLSA China Purchasing Managers’ Index dropped to a seasonally adjusted 44.8 last month from 45.1 in February. Any reading on these indexes below 50 means contraction.

The manufacturing component of the index continued to increased, rising for a fourth month from a record low of 40.9 in November. The export orders index rose to 41.4from 39.5 in February. New orders climbed to 43.6 from 44.2. Output gained to 44.3 from 43.9, while the employment index rose to 47.1 from 46.6, its second increase in eight months.

“A worsening of domestic manufacturing orders lies behind the drop in the PMI and accords with what we are seeing on the ground in the steel industry,” said Eric Fishwick, head of economic research at CLSA in Hong Kong. “Expect the production index to show softness in April......More encouragingly, export orders continue to improve,” he added “They are still falling but at the most moderate pace since October.”
Update: Rival Indexes At Work (Thursday 8 April)

Well, following a question in comments (see below) I think it worth adding a few details about the "other" PMI reading which is available, the China Federation of Logistics & Purchasing (CFLP) one. The CFLP PMI rebounded to 52.4% in March 2009, up from 49.0% in the previous month. The index was back to the expansionary zone of higher than 50% for the first time since October last year. Output index, new orders index and purchases of inputs index were also higher than the critical level of 50% in March. Except stocks of finished goods, all sub-indices were higher than their respective levels in the previous month. Of which, imports index grew strongly by 7.0 ppt. to 48.8% in March, compared to the previous month.

Many commentators have taken the CFLP reading at face value without bothering to contrast. Thus Bloomberg's Li Yanping, in a very bullish article:

China’s manufacturing expanded for the first time in six months, spurred by the government’s 4 trillion yuan ($585 billion) stimulus package. The Purchasing Manager’s Index rose to a seasonally adjusted 52.4 in March from 49 in February, the Federation of Logistics and Purchasing said today in Beijing in an e-mailed statement. A reading above 50 indicates an expansion. The expansion may help President Hu Jintao achieve his target of 8 percent economic growth for the world’s third- biggest economy. The report comes as he attends a Group of 20 summit in London where world leaders are discussing remedies for the worst global recession since World War II. Hu’s stimulus package already triggered jumps in urban investment and loan growth in the first two months of this year.
or PNB Paribas:

China Logistics Information Center (CLIC) release March PMI rose to 52.4 from 49 of February, the fourth months of continues improvement. PMI breached 50 the first time since September 2008, suggesting the industrial sector is resuming sequential expansion after 5 months of continuous drop.

Overall, the NBS PMI suggest that March industrial sector resumed sequential expansion despite further deterioration of export, this recovery is due to strong fiscal stimulus, aggressive credit expansion at 24.5% y/y pace and relative resilient household demand for property, autos and other durables. Though export outlook remain gloomy, however the G20 and global quantitative easing seem to be providing a floor to global demand. While Q2 growth should remain anemic, however the rebound of PMI suggests Q2 domestic demand growth is on an increasingly firm footing.

PNB Paribas basically put the difference down to differences in sample size:

The widening gap between CLIC PMI and CLSA survey PMI is due to different sampling, CLIC survey focused on 738 major industrials accounting for 20% of VAIO.
But as I indicate in comments, the difference is only in part about sample size, there is also a difference in methodology, largely connected with seasonal adjustment, not an un-important issue when the lunar new year impact is knocking around somewhere in the data. Indeed CLSA made this point abundantly clear in a note released alongside their report:

"It is true that the CFLP survey sample size is larger than that of the CLSA China PMI...therefore the standard error of the (population) estimates from the CFLP survey should be around 25 percent smaller than those from the China PMI," according to the CLSA note released on April 1. "However in practice all of this is academic. Differences in the samples are dwarfed by differences in how each set of statisticians adjust for seasonality in the data," said the note. CLSA said it had tuned the March figure as the February and March varied in number of days in a month and the latter month affected by the long Chinese lunar New Year holiday. Though both sides made seasonality adjustment, the CFLP figure was usually boosted by around three points by seasonality in March, said the CLSA note.

So you can accept the version you want to accept here, but be careful, since the level of confidence to be attached to either reading is moderate. At the end of the day the proof of the pudding here will be in the eating, when we get the March year on year industrial output data, ince this will either be just slightly up, or just slightly down on March 2008 -and remember in the meantime there has been a large expansion incapacity.

Second Update Monday April 13

And well, the mystery only deepens, since now we have an advance on the statistical data (thanks to Premier Wen Jiabao) and we learn that China's industrial output was apparently up by 8.3% year on year in March:

China's industrial output rose 8.3 percent in March, in a sign that a huge stimulus package is kicking in, Premier Wen Jiabao said in an interview published on Monday. Last month's growth accelerated from the 3.8-percent rise in the first two months as domestic demand continued to improve, Wen said, according to the China Securities Journal. Fixed asset investment and retail sales, which measure spending on infrastructure and consumption respectively, also increased quickly in the first quarter, he said in an interview while in Thailand for the ASEAN summit at the weekend. All this showed the economy was performing "better than expected" thanks to Beijing's measures to tackle the international financial crisis, he said. China in November unveiled an unprecedented four-trillion-yuan (580-billion-dollar) stimulus package to ward off the worst effects of the global crisis. However, Wen said the nation's export-dependent economy was still facing major difficulties due to a sharp contraction in foreign demand, which has placed increasing pressure on employment. "The international financial crisis has not yet hit the bottom. It's hard to say that China alone has steered away from the crisis," he said. "We should never overlook (the risks)." Wen's comments came just days before the National Statistics Bureau is slated to release first quarter data on the Chinese economy on Thursday. Tai Hui, an economist with Standard Chartered in Singapore, said the March growth in industrial output was boosted partly by companies filling their inventories after depleting them in recent months. However, the level of growth remains modest compared with before the crisis, and the overall economy is still weak, he said. "The economic environment,although it has improved, remains relatively weak due to the global financial turmoil," he said.
The mystery deepens in part becuase exports fell in March, more slowly than February, but still sharply - 17% yoy (following a 25.7% drop in Feb):

China's exports fell 17 percent in March, a less sharp contraction than the month before, amid signs the plunge in overseas demand may be easing, the government reported Friday. But while the decline in exports eased somewhat, a sharper weakening in imports pushed China's trade surplus to $18.56 billion, up from $4.84 billion the month before, the General Administration of Customs said. Exports totaled $90.3 billion in March, the fifth straight month of year-on-year declines due to the global downturn. In February, exports sank 25.7 percent from a year earlier in the worst drop in more than a decade. Imports in March fell 25 percent to $71.7 billion, the customs data showed. China's imports fell 24 percent in February. "The pace of contraction in exports has moderated notably from January-February levels, as export activity showed signs of stabilization," Jing Ulrich, chairman for China equities for J.P.Morgan, said in a report to clients. "Imports remained weak but there are some initial signs of recovery in China's raw materials demand, driven by government stockpiling and record imports of iron ore," she said.

It's frankly hard to understand why imports would be falling more than exports if you had a domestic demand lead recovery process at work. Brad Setser has a readable go at explaining things here:

The Wall Street Journal puts a more positive gloss on China’s March trade data than I would. To me the overarching story is simple: the data paint a story of deep distress in both the Chinese and global economy. China’s exports were growing 20% y/y (23% actually) in the third quarter of 2008. They were down nearly 20% (19.7%) in the first quarter of 2009. Imports though fell by more, in part because of the fall in oil prices. Imports fell close to 30% y/y in the first quarter. That isn’t just a function of falling commodity prices and fewer imported components either; US exports to China — which presumably include a lot of capital goods — are way down y/y. As a result, China’s trade surplus was larger in the first quarter of 2009 than in the first quarter of 2008 ($62 billion v $41 billion). The global shock has gotten rid of many of the world’s macroeconomic imbalances. American households are saving more and importing less, so the US deficit is down. The oil exporters are no longer running a surplus. Even Japan’s surplus has come down, as demand for Japan’s exports has fallen more rapidly than Japan’s commodity import bill. China’s surplus though has continued to rise.

So this is really the point I think: with a growing surplus (at this point, and on a year on year basis) China's economy isn't going to pull the rest of the world anywhere, since essentially it is still draining-off demand from elsewhere.

But even if China seems an unlikely candidate to pull the global train out of the mire, we still need to try and understand what it is exactly that is going on in Chinese domestic industrial activity. One part of the explanation undoubtedly lies in domestic loan growth. Bloomberg report that China’s new lending surged more than sixfold from a year earlier to a record 1.89 trillion yuan ($277 billion) in March, which compares with the previous high of 1.62 trillion yuan posted in January. Domestic loans grew 29.8% in March, from a year earlier - analysts had been expecting a 25.1% jump. M2 - often considered the broadest measure of money supply - grew year on year by 25.5 percent, according to the central bank.

Bloomberg report that this is the fastest growth rate for M2 since they began compiling data in 1998. China’s banks, which are mostly state-owned, have already implemented new lending almost up to the government’s target of 5 trillion yuan of new loans this year. Indeed, according to JPMorgan Chase & Co. lending may exceeed the target level by as much as 3 trillion yuan. China has certainly mounted the credit tiger in its race to meet the government's official growth target of 8% this year, but while growth propelled by government stimulus and easier access to credit may spawn new projects and stem job losses in China, it won't necessarily translate into industrial profits, and indeed in the medium term it may even lead to a large pile-up of Non Performing Loans.

While no one at this stage believes that the percentage of such loans could reach 2003 levels (20.4% of the total, or 16.5% of GDP) many believe the danger that Chinese vabks could see another wave of loan defaults is rising. This, is the view being taken, for example, by Fitch Ratings, who in a recent report warn that loan defaults could rise to 5% or 6% of total lending, as Euromoney's Sudip Roy argues:

The biggest proportion of new lending by the banks is through discounted bills, which supply working capital. Long-term to medium-term corporate loans are the second-biggest component. More than 70% of the new lending, according to official figures, is through these two channels, which should be low-risk financing."It is hard to predict the quality of all of the lending in January and February but a large proportion of it was mid- to long-term loans to infrastructure projects with stable funding and government support," says Lian Ping, chief economist at Bank of Communications in Shanghai... banks often categorize loans that are rolled over as performing even though they have not been repaid on their original maturity date. "In practice, this means that a one-year working capital loan that is not repaid at maturity can take another one or more years before being classified as nonperforming," says Fitch. Instead, many banks classify these advances as special mention or even normal loans. Special mention loans are effectively non-performing in all but word.

What’s especially worrying, according to Fitch, is that if a comparison is made for each of the 16 leading banks of the levels of their equity and loan-loss reserves against their portfolio of NPLs and special mention loans, then in every case the latter "swamped reserves, while for many banks equity also was severely affected". And these banks are the largest and healthiest in the country, adds Fitch.

In a sign that some of the lending is already reaching infrastructure and real estate projects China's National Statistics Bureau said on Monday that spending on property development was up from a year earlier by 4.1% in the first quarter, following a rise of only 1% in January and February. Property sales were also up year on year (by 8.2%) in the first quarter, after sliding in January and February. However urban real estate prices in 70 major cities were down 1.3% in March, compared with March 2008, confirming the general deflationary environment.

Further foreign direct investment into China fell for a sixth month in March, dropping 9.5 percent from a year earlier to $8.4 billion, as compared with a 15.8 percent decline in February. For the first quarter as a whole, spending fell 20.6 percent to $21.8 billion. Foreign-invested businesses account for 30 percent of industrial output, 55 percent of trade and 11 percent of urban jobs according to Commerce Ministry spokesman Yao Jian at the press conference where the FDI data were released. The rate of decline in FDI is slowing however, since while this is the first time since 2000 that investment from abroad has fallen for six straight months, the absolute value of investment in March was the largest in nine months and the decline from a year earlier was the smallest in the last three months. Thus it would be premature to draw any definitive conclusions at this point.

And just one more data point to add to all those quandrys, China’s March power output fell about 2 percent from a year earlier according to an official from the China Electricity Council, citing preliminary data. The drop is smaller than in previous months, the official said today, declining to be named before the official data release.

Power production fell 3.7 percent in the first two months from a year earlier, the National Bureau of Statistics said on March 12. Further, China's power output fell 0.7 percent in March from a year earlier, according to Caijing magazine on April 3, citing the State Grid Corp. of China, the country’s biggest electricity distributor. On the other hand China Central Television reported on April 11, citing the Electricity Council, that electricity use was up “noticeably” in March from February. Now this little snippet of information would appear at first sight to be at variance (but not in contradiction) with the March year on year data, until you consider the sort of seasonal influences we have been encountering in this post. So it is quite possible that power consumption was up sharply month on month, and down slightly year on year. What seems hard to understand, at least from where I am sitting, is how power consumption can have fallen while industrial output surges 8.3%. When you put this together with the import data, and the rising surplus, then something quite simply doesn't add up here.

This impression that all may not be moving as planned under the "official version" would seem to find some confirmation in the latest reports that the Chinese government is considering additional stimulus measures to boost consumption and bolster growth. According to a report in the official China Securities Journal - citing Gao Huiqing, a researcher at the State Information Center - the government will issue some “guideline” policies and continue to use fiscal and taxation measures to spur an expansion. This follows this weekends statement from Premier Wen Jiabao that China would “closely” monitor changes in the domestic and world economy and “hammer out” new response plans when needed.

Gao, who is affiliated with the National Development and Reform Commission, indicated that the kind of recovery mentioned by Premier Wen, spurred as it is by rebounding inventories and sales of property and cars, may be short-lived without a global rebound which will increase demand for Chinese exports.

“While the stimulus is indeed having an effect on loan growth and some measures of economic activity, the trend decline in exports is unbroken,” said James McCormack, head of Asia sovereign ratings at Fitch Ratings in Hong Kong. “Chinese gross domestic product growth will remain below potential until the global economy recovers.”

Indeed according to Zheng Xinli, the deputy policy research head of the Chinese Communist Party, China’s 2009 exports may shrink by as much 10 percent over 2008. So what we have here, is more like a make and mend, hold the line, stimulus approach, as the government tries to soften the external blow, rather than a full blooded, domestic demand driven recovery.

According to initial reports the new package is likely to be focused on social welfare spending and on boosting consumer consumption, both of which are to be fuelled by the record fiscal deficit China is expected to run this year. China is, for example, subsidizing 20 billion yuan this year on rural purchases of televisions and refrigerators and plans to increase spending on welfare by 29 percent. In the long term, the government is also planning an expanded social safety net, and the State Council published earlier this month an 850 billion yuan health-care plan, including building at least one hospital in every county and expanding medical insurance coverage to 90 percent of the 1.3 billion population by 2011. All welcome measures, but not surely the ones which will lead us all collectively away from the abyss.