China's big factories rebound on new exports

China's factories grew more than expected in February as new export orders for big firms bounced back, a government survey showed, while a private-sector report portrayed a different picture of smaller companies lagging behind the rebound.

China's official purchasing managers' index (PMI) rose to 51.0, above expectations of 50.7 and higher than 50.5 in January, while the final reading of the HSBC PMI stood at 49.6, a shade higher than January's reading of 48.8, but still under the 50-point threshold demarcating expansion from contraction.

Export orders showed a bigger divergence, with the government's new export orders sub-index rising to 51.1 in February, the first indication of expansion in four months and the highest reading since May 2011.

The HSBC PMI export sub-index slid to an eight-month trough of 47.5, suggesting orders were shrinking.

It is not uncommon for the two data series to diverge in their findings. They use differing survey samples and the government survey is only partially seasonally adjusted -- a vital distinction given the Chinese Lunar New Year holiday disruption to production cycles.

"In the past six years, the month after Chinese New Year always saw a rise of PMI readings. Therefore, PMI data in January and February should be taken with a grain of salt," Ting Lu, China economist with Bank of America/Merrill Lynch in Hong Kong wrote in a note to clients.

The twin data sets underline that a rebound in the vast Chinese factory sector should prevent a hard economic landing, but that it has yet to be secured, signalling to analysts that it is too early to think that the government will ease back from pro-growth fine-tuning of economic policy.

The market perception is that small firms in particular are in need of the banking system liquidity and other support that the government has unveiled in a series of policy tweaks since its fine-tuning campaign started in the second half of 2011.

The Australian and New Zealand dollars, already buoyed by robust domestic data, edged higher against the US dollar after the dual PMI readings.

Copper though held steady after having fallen more than 1% on Wednesday.

"The headline number improved, but the outlook is not very promising as inventory built up quickly and new orders only rose slightly. Other evidence from loan supply and sector-level data also signal further weakness," said Nomura's chief China economist, Zhang Zhiwei.

"The China Securities Journal reported that new loans in February may be just around RMB500bn, versus the Consensus of RMB800bn. Steel production in the first 20 days of February was weak. The property and export sectors continue to cool down in the first two months of 2012," he wrote in a client note.

The official PMI was at its highest level since 51.2 in September, the figures from the National Bureau of Statistics showed.

"The February PMI continued to pick up, further confirming a trend that the economy is stabilising," Zhang Liqun, a researcher with the Development Research Centre of the State Council, said in the official statement.

"Different from January, last month's expansion in the manufacturing sector is mainly driven by heavy industries. But the export and investment demand is expected to ease in the coming months, albeit at a slower pace. Input price is accelerating evidently, a reflection of rising imported inflation," Zhang said.

Formidable Headwinds

PMI survey methodology around the world maintains that a reading below 50 indicates falling factory output. HSBC says a PMI reading of as low as 48 in China still suggests annual growth of 12-13% in output, even if activity slowed on the month.

The final reading for HSBC's China's PMI is roughly in line with a preliminary, or flash, estimate of 49.7, and a far-cry from the depths seen during the global financial crisis when the PMI hit a low of 40.9 in November 2008.

Still, China's economy faces formidable headwinds as exports falter due to weakening demand in the United States and Europe, alongside a downturn in the once red-hot property sector in response to tightening steps by Beijing.

China's annual economic growth is widely expected to slow to just over 8% in the first quarter from 8.9% in the previous quarter, the fifth consecutive quarter of slowdown.

"Deteriorating external demand is adding more downside risks to growth in the absence of a strong comeback in domestic demand," said Qu Hongbin, HSBC's China economist.

"We expect the People's Bank of China to step up policy easing efforts as inflation pressures recede."

Many analysts expect the central bank to continue its steady policy easing by cutting the amount of cash that banks must hold as reserves to crank up credit to ward off sharper growth slowdown.

China announced a cut in its reserve requirement ratio (RRR) by 50 basis points to 20.5% on Feb 18, releasing about 400 billion yuan that could be used for bank lending. It was the second 50-bp cut in the RRR in three months.

The deep-pocketed government has also cut taxes for small firms, which are vital for generating economic growth and jobs, to help them cope with a credit squeeze and weaker exports.

Longer-term, China needs to change its economic model, which for years has relied on the export sector to drive growth, the World Bank said in a report this week. The government must relax its grip on industry and move towards free markets, it said.