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China economy

China’s factory activity to hit 8-month low due to trade war

  • Manufacturing sentiment reports due this week expected to show grim mood for large and small firms
  • First gauges of the impact of US tariffs won’t factor latest tensions
PUBLISHED : Tuesday, 30 October, 2018, 8:00pm
UPDATED : Thursday, 01 November, 2018, 4:10pm

Activity in China’s factories is expected to slow further in October, pointing to a dampening of the overall growth momentum in the world’s second largest economy, as the effects of the trade war with the United States begin to show.

Two manufacturing sentiment indices to be published this week will be the first gauges of the impact of tariffs on US$200 billion of Chinese imports that took effect September 24.

China’s official manufacturing purchasing managers’ index (PMI) for October, which is dominated by the sentiment of large, state-owned firms, is forecast to slip to 50.6 when it is released on Wednesday, according to a median estimate of economists in a Bloomberg survey.

A reading of 50 on the PMI marks the point between expansion and contraction and the expected October figure, down from 50.8 in September, would be its lowest level since February.

China’s yuan in spotlight amid key economic data releases this week

The Caixin October PMI, due out on Thursday, is a better gauge of the sentiment of smaller, privately owned firms. It is projected to remain stable at 50, right on the dividing line between contraction and expansion in the sector.

But neither index will reflect the impact of the latest development that threatens to escalate the trade war further.

Bloomberg reported late on Monday that the US was preparing to announce tariffs on all remaining Chinese imports, about US$267 billion worth of goods, in early December if next month’s talks between US President Donald Trump and Chinese President Xi Jinping fail to make progress.

Trump said in a television interview on Monday night that he expected the trade conflict to result in a “great deal” for the US and repeated that the additional sanctions on all Chinese imports were “ready to go”.

He did not give any indication that he expected progress in his scheduled meeting with Xi.

Trump talks ‘great deal’ with China to ease trade war tensions – for now

The export orders component in both PMI reports will be closely monitored for signs of the trade war’s impact. If US tariffs become too costly for Chinese exporters to fully absorb they will hurt manufacturing activity.

The US this year has already imposed tariffs on US$250 billion in trade with China.

Tariffs of 10 per cent on US$200 billion in imports that took effect in September are due to increase to 25 per cent on January 1. This has caused many Chinese exporters to “front-load” production to this quarter and deliver orders for early next year to the US before the tariff increase takes effect.

This has raised concerns that production could slow considerably early next year due to a lack of new orders.

The trade war is not the only challenge facing Chinese manufacturers.

“In addition to headwinds from the trade war, China’s economy is also being hit by domestic problems caused by the government’s policy of cracking down on risky lending in recent years,” said Carie Li, a Hong Kong-based economist with OCBC Wing Hang Bank.

Li added that private companies and local governments continued to face difficulties in raising funds, pointing to weak investment.

Samuel Tse, economist at DBS Bank, said industrial activity was expected to moderate further due to weakening domestic demand.

Beijing is currently using a mix of modest monetary and fiscal stimulus to try to stabilise growth, instead of following its old debt-fuelled growth model which would continue to build risks and vulnerabilities in the country.

Analysts predict the People’s Bank of China (PBOC) may cut reserve requirements for banks again by the end of the year, or early next year, as it steps up moves to lower financing costs to spur growth.

The reserve requirement – the amount of money banks are required to hold at the central bank – has already been cut four times this year. Further measures to help local governments and innovative industries with bank borrowing and bond issuance are also expected.

China’s factory-gate inflation cools for third month in row as trade war makes impact

On the fiscal side, the government may rely on tax cuts to support domestic consumption, although – unlike the US – China has never before stimulated its economy through a large-scale tax cut.

Larry Hu, economist at Macquarie Capital noted that the size of China’s previous tax cut was insignificant compared with its massive infrastructure and property spending.

China’s overall tax revenue actually accelerated to 13 per cent in the January-September period, compared to 11 per cent in the previous year, due to stricter enforcement, according to Hu.

This was despite nominal GDP growth slowing to 9.9 per cent from 11.2 per cent.

China’s yuan in spotlight amid key economic data releases this week

Jiang Chao, macroeconomic research analyst at Haitong Securities, said China was aiming to make structural changes to the make-up of its fiscal spending over the long term, rather than simply increase total fiscal spending.

The nation had been relying on investment and infrastructure spending for its economic development even though the economic efficiency of this approach had been falling due to rising administrative costs, he said.

Chao predicted fiscal expenditures would be likely to increase for social security while infrastructure spending and administrative costs would decrease.

In recent years, he said, the government had been controlling administrative costs, signalling a more conducive business environment.

“Export tax rebates, and salary and corporate tax cutting measures should support domestic consumption,” Chao said. “China’s spending on social security has been relatively weak, constraining consumer spending.”