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Tom Holland

Yesterday Beijing released one of the most closely followed indicators of China's economic health. The prognosis was at best mixed.
Initial media reports were quick to point out that China's official purchasing managers index, or PMI, dropped to 50.2 in June from a level of 50.4 in May, flagging this fall as a deterioration in business conditions.
In fact the PMI, which is derived from a mid-month survey of manufacturing executives, is a diffusion index. Any score above 50 represents a strengthening in activity over the previous month.
So June's reading, the seventh in a row above 50, implies that China's economic conditions are improving, although only just. 
Still, an improvement in the manufacturing sector should be good news for anyone concerned about reports of a deepening slowdown.
Except there's a problem. The official PMI has a rival. Sponsored by HSBC, specialist research company Markit also compiles a manufacturing purchasing managers index for China.
Its June figure will only be published today, but judging by the advanced 'flash' estimate released 10 days ago, it will paint a rather different picture of China's economic strength.
 According to the flash estimate, which is based on 85 to 90 per cent of the survey's responses and is usually a pretty good guide to the final figure, HSBC's PMI sank to 48.1 in June, down from 48.4 in May. That's the seventh reading in a row below 50 and a clear indication that things are getting worse.
This divergence is nothing new. Since 2005, the two PMI readings have been out of step on one month out of every three.
As a result, investors are often tempted to reject one or other or even both surveys as just another example of how difficult it is to get decent data out of China.
But dismissing them out of hand would be a mistake. There are important differences between the way the two indices are compiled. Know what they are and it's possible to extract useful information from the two surveys, even if they are heading in opposite directions.
 Both surveys ask factory executives whether order books, payrolls and a handful of other factors have improved or deteriorated over the last month. Then they weight the answers to come up with an index score. However, there are big differences between the companies they survey. The official survey is based on a much bigger sample: 820 companies compared with some 430 for the HSBC PMI.
But the official survey tends to focus mainly on larger, often state-owned manufacturers. Although the compilers do not publish the composition of their sample, Wang Qinwei and Mark Williams at Capital Economics  estimate that almost 70 per cent of respondents in the official survey are large companies, while only 10 per cent are small firms.
In contrast, HSBC's sample is made up of around 30 per cent large companies, 30 per cent medium-sized firms, and 40 per cent small concerns.
Arguably this is more representative of the manufacturing sector as a whole, and it can certainly make a big difference to the monthly readings.
Because larger manufacturers, especially in the state sector, have stronger links with banks and are more reliant on loans from the financial system, their responses are more influenced by credit conditions.
As a result, argue Wang and Williams, the official PMI tends to outperform HSBC's when the government is loosening bank credit, as it did in 2009 and as it is now.
Add in the clear seasonal fluctuation in the official index, which shows a big rebound following the Lunar New Year, and you get an explanation for the recent divergence between the two PMIs, and a better picture of what is really going on.
The environment may be improving for big manufacturers as official credit policy is loosened. 
But conditions for smaller companies - the engine room of China's economy - remain tough, and they are getting tougher.



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