China Manufacturing Unexpectedly Contracts as Orders Drop

China’s manufacturing unexpectedly shrank for the first time in nine months as new orders contracted and output rose at a slower pace, signaling the slowdown in the world’s second-biggest economy is deepening.

The Purchasing Managers Index fell to 49.2 in August from 50.1 in July, the National Bureau of Statistics and China Federation of Logistics and Purchasing said yesterday in Beijing. Australia & New Zealand Banking Group Ltd. cut its estimate for China’s full-year growth after the report.

The data increase pressure on Premier Wen Jiabao to reverse the slowdown ahead of the transfer of power to a new Communist Party leadership that begins later this year. Record unemployment in the euro area and a jobless rate stuck at more than 8 percent in the U.S. may crimp an export rebound while slumping corporate earnings, bad debts at banks and property curbs are restraining investment in China.

“The government won’t want to hand over an economy in a hard landing to the next administration, so authorities are likely to become bolder with policy easing, said Liu Li-Gang, chief China economist at ANZ in Hong Kong. “They could continue to use tax relief and faster approval of infrastructure investment to instill confidence, but the most effective policy tool in the short term is to aggressively ease the reserve- requirement ratio.”

Support Lending

Liu lowered his 2012 growth estimate to 7.8 percent from 8.2 percent and said the risks to the forecast “are biased towards the downside.” He didn’t give a projection for the third quarter.

The People’s Bank of China cut interest rates in June and July and lowered the reserve-requirement ratio for banks three times starting in November as part of the government’s efforts to support lending and boost growth. The ratio, which is now 20 percent for the biggest banks, hasn’t been reduced since May.

The benchmark Shanghai Composite Index (SHCOMP) of stocks fell 0.3 percent on Aug. 31 to the lowest level since February 2009, capping a fourth month of losses, after declining earnings from companies including Sany Heavy Industry Co. underscored the impact of the nation’s economic slowdown.

The yuan strengthened for the fifth week, the longest winning streak since April 2011, on bets policy makers will act to revive the economy. The currency has lost about 0.9 against the U.S. dollar this year after rising 4.7 percent in 2011.

Orders Slump

The August PMI reading was lower than the estimates of 24 of the 25 economists in a Bloomberg News survey that had a median forecast of 50.0, the dividing line between expansion and contraction. The index is based on responses from purchasing managers at 820 companies in 31 industries.

A gauge of export orders was unchanged from the previous month at 46.6, marking the third straight contraction, federation data showed. The decline in the new orders index deepened to 48.7 and a measure of output fell to 50.9.

“The index reflects continuing difficulties for the manufacturing sector and without strong supportive policies amid weak global demand, the PMI may drop further,” said Hu Yifan, a Hong Kong-based economist with Haitong International Securities Group who previously worked for the World Bank. A reduction in banks’ reserve requirements “would send a positive signal to the markets to boost confidence particularly now that the PMI has broken the critical mark of 50.”

Stabilizing Growth

A separate purchasing managers index released by HSBC Holdings Plc and Markit Economics indicated that manufacturing may have contracted for a 10th month in August, according to a preliminary reading on Aug. 23. The final number for the survey, which covers more than 420 companies and is weighted more toward smaller businesses, is due tomorrow.

The employment gauge in yesterday’s survey was below 50 for a third month and at the lowest level since January, while HSBC’s preliminary reading showed the sixth straight contraction.

The deterioration in labor conditions “could push Beijing to step up policy easing or stimulus in supporting growth,” said Lu Ting, chief China economist at Bank of America Corp. in Hong Kong. “In this year of leadership transition, employment and social stability should be of top concern to politicians,” he said.

China’s gross domestic product expanded 7.6 percent in the second quarter from a year earlier, the slowest pace in three years. Estimates for growth this quarter ranged from 7.4 percent to 8.3 percent in a Bloomberg News survey last month.

Stabilizing Growth

The difficulties in stabilizing growth are “relatively large,” the official Xinhua News Agency cited Wen as saying during an inspection tour to Guangdong province on Aug. 24 and 25. Wen called for extra measures to promote exports to meet the economic expansion target, according to Xinhua. The premier in March set a 7.5 percent growth goal for this year.

In a report late yesterday, Xinhua cited Wen as saying the country needs to resolutely curb speculative property investment and that controls on the real-estate industry are still in a “critical period,” indicating loosening policies won’t include easing home-purchase limits.

Zhang Zhiwei, Hong Kong-based chief China economist at Nomura Holdings Inc. said he expects a cut in banks’ reserve- requirement ratio in early September, probably before the release of the monthly data that will start on Sept. 9 with inflation and industrial output. The government’s concern that property prices will rebound means interest rates won’t be lowered, he said.

UBS AG economist Wang Tao estimates industrial output growth eased to 8.9 percent from a year earlier in August, which would be the first reading below 9 percent since May 2009.

Profits Decline

Manufacturers’ earnings are falling as the slowing economy curbs demand. Chinese industrial companies’ profits declined in July by the most this year, a government report showed Aug. 27.

Sany Heavy, China’s biggest construction-equipment maker, on Aug. 30 posted a 13 percent decline in first-half profit on slumping demand for excavators. Eastern China-based Weichai Power Co., the world’s No. 1 maker of heavy-duty engines, reported a 26 percent drop in first-half sales and a 46 percent decline in net income.

“The government doesn’t want to be too aggressive with easing for fear of reigniting asset bubbles,” said Song Seng Wun, an economist with CIMB Research Pte. in Singapore. “But with the whole economy losing steam, they may need to switch from a gradual acupuncture-treatment-style approach to a western medicine-based approach of taking a Panadol and hoping for the best.”

--Zheng Lifei. With assistance from Ailing Tan in Singapore and Penny Peng in Beijing. Editors: Nerys Avery, John McCluskey

To contact Bloomberg News staff for this story: Zheng Lifei in Beijing at lzheng32@bloomberg.net

To contact the editor responsible for this story: Paul Panckhurst at ppanckhurst@bloomberg.net

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