Home Economy, Policy & Business China’s slowdown owes to weak demand rather than supply issues

China’s slowdown owes to weak demand rather than supply issues

Louis Kuijs
A detailed analysis of the official manufacturing PMI survey points towards an industrial slowdown caused mainly by weakening domestic demand
Head of Asia Economics at Oxford Economics
Workers at an automobile assembly line in Linhai, Zhejiang Province, China

Preliminary indicators, including PMI data, show that economic momentum in China’s industry worsened in October amid the downturn in residential real estate and continued impact from repeated COVID outbreaks.

China’s official manufacturing PMI fell 0.4 points to 49.2 in October (Exhibit 1), while non-manufacturing PMI dropped to 52.4, from 53.2 in September. High frequency indicators show further declines in housing sales in major cities and car sales.

The increase in the Markit Caixin manufacturing PMI to 50.6 bodes well for exports. But in our view, the official PMI is a better gauge of overall conditions in the domestic economy.

In our assessment, supply constraints such as electricity shortages and supply chain problems are not a paramount problem anymore. As we had expected, electricity shortages have eased throughout October, following a range of policy measures to boost coal production and lower coal prices (surging high coal prices had reduced the incentive for electricity producers to produce, earlier on). By end-October, coal future prices had come down 45% from their peak on October 19.

Exhibit 1: A further slowdown of momentum

More generally, a detailed analysis of the official manufacturing PMI survey points towards an industrial slowdown caused mainly by weakening domestic demand in China.

The production component of the manufacturing PMI fell faster in October than the one for new orders. However, the bigger picture takeaway is that these two indicators have been falling in tandem since mid-2020, while the most recent prints do not suggest an extraordinarily tight demand-supply situation in industry (Exhibit 2).

Exhibit 2: New orders and production have slowed in tandem

As production momentum in industry has weakened steadily since May this year, raw material inventories have broadly held steady (Exhibit 3). That also suggests production isn’t held back by tight supplies of inputs.

The official PMI’s ‘supplier deliveries’ sub-component has fallen alongside the ‘purchases’ and ‘production’ ones in recent months, rather than lagging them (Exhibit 4). That fits with the slowdown in industry being more a demand issue than a supply one.

Exhibit 3: Raw material inventories have held steady as production has slowed

The apparent robustness of exports last month is also in line with weak domestic demand being the key reason for the slowdown in industry, rather than domestic supply constraints.

According to South Korea’s trade data, China’s exports to the country rose 24.5% year-on-year in October, in US$ terms (China’s imports from South Korea grew at a similar pace). More generally, while China’s official manufacturing PMI’s new export order sub-component is still relatively low, it rose 0.4 points in October, to 46.6.

Exhibit 4: Supplier deliveries have fallen alongside purchases and production

Having said that, another sharp rise in the manufacturing PMI’s input price sub-component underscores how much producer prices have increased recently due to spikes in energy and raw commodity prices.

This is a risk that bears monitoring.

Breaking down the value added in industry data, our estimates indicate that heavy industry has slowed down much more than other industrial sectors through September (Exhibit 5). While electricity shortages and production cuts played a role in September, the steady slowdown in heavy industry in recent months is likely largely because of the downturn in the real estate sector, which has strong backward linkages to heavy industry.

Exhibit 5: Heavy industry has slowed much more than other industrial sectors

Slower growth expected

Looking ahead, even with easing supply side pressures, we expect year-on-year growth in industry and the wider economy to slow further in the fourth quarter amid the real estate slowdown and another COVID outbreak.

In response, we think policymakers will take more steps to shore up growth, including ensuring ample liquidity in the interbank market, accelerating infrastructure development, and relaxing some aspects of overall credit and real estate policies. This policy easing, the impact of which we expect to kick in largely next year, should moderate the downward pressures on growth in 2022. We expect full-year GDP growth of 5.4% next year, after 8% this year.

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Head of Asia Economics at Oxford Economics

As Head of Asia Economics, based in Hong Kong, Louis leads the firm’s macroeconomic research and forecasting for Asia, oversees the team of economists across the region and serves clients globally. Before joining Oxford Economics in 2015, Louis held senior positions in both the public and private sectors, including at the International Monetary Fund (IMF) in Washington DC, the World Bank in Beijing and at the Royal Bank of Scotland in Hong Kong. While with the World Bank, he led the well-regarded China Quarterly Update, headed the Bank’s mid-term review of China’s 11th Five-Year Plan and led research on China’s saving and investment, rebalancing, and long-term growth and structural change. Mr. Kuijs is a well-known observer of the Chinese economy and contributes regularly to the international media.

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