The revival of Chinese manufacturing activity in March could signal light at the end of the economic tunnel for the globe’s biggest trading nation – and not a millisecond too soon for an Asia region desperate for growth engines.
The return of the Caixin purchasing managers’ index to expansion territory last month – to 51.1 – marks the fifth straight month of improvement, the best winning streak China has seen in more than two years.
That comes on top of official government PMI data released on March 31 reporting the highest reading in a year, ending a five-month contraction.
Both data series came in better than expected and lent credence to Premier Li Qiang’s assurances that the all-important industrial sector is gaining enough momentum to drive a recovery in the world’s second-biggest economy.
Indeed, upbeat messaging is spreading. Wang Zhe, senior economist from Caixin Insight Group, notes that mainland business optimism is also on the rise.
Analysts at advisory firm China Beige Book write that “March data show the economy is poised for a strong end to Q1. Hiring recorded its longest stretch of improvement since late 2020. Manufacturing picked up, as did retail.”
In the first two months of the year, profits at China’s industrial companies rose 10.2% from a year earlier, prolonging a winning streak that began in August.
“Revenue growth at industrial enterprises picked up markedly as market demand continued to recover and industrial output expanded rapidly,” says Yu Weining, an analyst at the National Bureau of Statistics. “That created favorable conditions for their profits to increase.”
Yet the eyes of the world are fixed on what China’s leaders do next. Hints of greens shoots aside, global investors remain worried about the deflationary pressures bearing down on the economy.
Similar concerns surround China’s unresolved and massive property crisis, the crushing debt loads amassed by local governments around the nation and record youth unemployment.
This all has many global funds in a trust-but-verify crouch. The question is whether “looking forward, the roll-out of policies such as the large-scale equipment upgrade will continue to support demand for the manufacturing sector,” says analyst Xiao Jinchuan at Guangfa Securities Co.
Li and President Xi Jinping’s ministers have indeed been acting to revive domestic spending. Efforts include pledging to deploy public funds as needed to incentivize consumers and businesses to upgrade goods from cars to machine tools to construction equipment to appliances to electronics. In theory, such steps augur well for industrial firms.
Recent data “add to wider evidence of a stimulus induced pick-up in activity,” says economist Zichun Huang at Capital Economics. Yet Huang speaks for many when she warns “we think this recovery will continue in the near-term but won’t prove durable and that the economy will be weakening again by year-end.”
It’s here where economists think Xi and Li must tread carefully. PBOC Governor Pan Gongsheng, too, as he balances the need to head off deflationary pressures without facilitating a fresh increase in financial leverage, a problem on which the central bank has made progress.
Analysts at Maybank note that news that PMI data had “a fairly solid first quarter” could “put the Chinese government on hold in rolling out bigger monetary and fiscal stimulus to provide an additional much-needed boost to the economy.”
The risk is that the PBOC makes the Japan-like mistake of letting deflationary forces fester without bold action. Another is that officials in Beijing are overconfident about the state of global demand.
Looking at China’s manufacturing growth, says Jeremy Mark, senior fellow at the Geoeconomics Center of the Atlantic Council, it’s safe to “assume that much of that expansion is likely to go straight to exports.”
Yet Europe is walking in place as economists continue to slash growth forecasts for Germany, which is skirting recession.
“Germany is struggling,” says International Monetary Fund economist Kevin Fletcher. “It was the only G7 economy to shrink last year and is set to be the group’s slowest-growing economy again this year, according to our latest projections.”
Japan is also struggling to find its economic footing. “Japanese business sentiment is treading water,” says economist Jeemin Bang at Moody’s Analytics. Bang adds that “manufacturers are struggling,” as evidenced by the Bank of Japan’s “Tankan” index for large manufacturers falling to 11 from 13 prior in the first quarter.
Strategist Maki Sawada at Nomura Securities Co warns of signs of “eroded confidence” in the “future prospects of Japan’s manufacturing and nonmanufacturing sectors.” And, awkwardly, at a moment when the BOJ is embarking on its first tightening cycle in 17 years.
The US, meanwhile, remains a wild card as the Federal Reserve slow-walks the interest rate cuts virtually every economist on the globe thought were a given this year.
At this point, the best-case scenario is that “by the time the Fed meets in June, the data should be convincing enough for them to commence its rate normalization process,” says economist Jeffrey Roach at LPL Financial. In general, though, “markets need to have the same patience the Fed is exhibiting,” he notes.
Uncertainty about the trajectory of rate policies in Washington and Tokyo will continue to make for volatile conditions in currency markets.
“The very accommodative stance of BOJ and data that continue to show the fragility of Japan’s ‘virtuous cycle’ economic recovery underscore the divergence in policy stances” with the Fed, write Westpac strategists in a recent note.
Yet for China, the key is accelerating structural reforms. The US$7 trillion stock crash from the market’s 2021 peak to January has subsided to some extent. The worries driving the rout, though, remain live ones for many global investors.
Take Ray Dalio’s recent headline-grabbing observations about a Chinese economy with which he’s been engaging for decades. In a recent LinkedIn post, the founder of hedge fund giant Bridgewater Associates warned of China courting a Japan-like “lost decade,” while exploring the risks of the “100-year big storm” about which Xi warned in 2018.
“When there is a lot of debt and big wealth gaps at the same time as there are great domestic and international power conflicts, and/or great disruptive changes in nature, and great changes in technology, there is an increased likelihood of a ‘100-year big storm,’” Dalio writes.
Dalio’s top worry is that by acting too slowly to fix the property sector and reduce municipal debt levels China risks a “balance sheet recession” of the kind that hobbled Japan in the 1990s. He argues that China must accelerate deleveraging efforts and cut borrowing costs that Japan did 30 years ago.
On the need for bigger PBOC rate cuts, Dalio says that “in my opinion, this should have been done two years ago, and if not done will probably lead to a lost decade.” The problem, he adds, is that “when the debt becomes too large to pay off and there are big wealth gaps, that causes the cycle to reverse.”
Yet uncertainty abounds as to how Beijing will proceed. As Dalio put it, “no one knows how far the pendulum will swing back toward the more Maoist/Marxist ways of doing things. The impediment is that communicating more directly is not the Chinese leadership’s traditional way of doing things, which, as China goes back toward the more traditional ways of doing things, is understandable.”
For China’s 2024, the key issue is how assertively Xi and Li move to repair the cracks in the financial system – the very ones that had capital fleeing in recent quarters. Foreign direct investment into China fell to a 23-year low in 2023, with just $42.7 billion of inflows.
This means tackling the underlying cause of China’s financial imbalances, not just the side effects. Beijing, economists say, must redouble efforts to repair the property sector, strengthen capital markets, champion the private sector, recalibrate growth engines from exports to domestic demand, internationalize the yuan and build bigger social safety nets to encourage households to save less and spend more.
As Moody’s Investors Service analyst Madhavi Bokil puts it: “Structural challenges including the aging population, weaker productivity growth and elevated debt levels will continue to weigh on potential growth over the medium term. For now, the economic environment remains difficult, with factors that stymied growth in 2023 still present.”
The worry among global investors, Bokil adds, is that a “protracted decline in the property sector, deterioration in regional and local governments’ strength, domestic policy uncertainty, slower global demand growth and high geopolitical tensions present hurdles to the growth outlook.”
It’s vital, too, that Xi’s team resist the urge to engineer a weaker yuan exchange rate. So far, it’s done just that even as the Japanese yen tests 34-year lows. The yuan is down just 1.9% this year versus the yen’s 7.5% decline.
A top Xi priority over the last eight years has been internationalizing the yuan. Manipulating the exchange rate might squander that progress and draw Washington’s ire as a contentious US election approaches. Nothing brings President Joe Biden’s Democrats and Republicans loyal to Donald Trump together faster than a chance to be tough on China.
Yet from a global soft power standpoint, China’s revival as a reliable and stable growth engine would be just the thing. The good news is that hints of a rebound in China’s manufacturing activity in March appear to signal better days ahead on the factory front.
But until policymakers make demonstrable progress on various other economic and financial measures it won’t be clear that China is genuinely seeing light at the end of the tunnel.
Follow William Pesek on X at @WilliamPesek