China factories struggle, adds to expectations for stimulus

By Kevin Yao and Adam Rose

BEIJING (Reuters) - Persistent weakness in China's manufacturing sector reinforced fears of a sharper-than-expected slowdown at the start of 2014, and some government economists think authorities have already started boosting spending to put a floor under growth.

On Tuesday two surveys showed that manufacturing struggled in March, with activity at smaller, private firms contracting for a third month, adding to a run of disappointing data that has sparked speculation of imminent government-led stimulus.

The official purchasing managing index (PMI) edged up to 50.3 in March from 50.2 in February, pointing to slight expansion, but some economists said even that suggested weakness given activity typically picks up more after the Lunar New Year holidays in February.

The Markit/HSBC Purchasing Managers' Index (PMI), which focuses more on the private sector, fell to an eight-month low of 48.0 in March. The index has been below the 50 level since January, indicating a contraction this year.

"We're still in a subdued part of the cycle," said Louis Kuijs, chief China economist at the Royal Bank of Scotland.

"I still don't think the downward pressures are tremendous, but they are large enough for the government to really start to talk about the need to support growth."

In March, sources told Reuters the central bank was prepared to loosen monetary policy in order to keep the world's second-biggest economy growing at the government's target rate of 7.5 percent.

STIMULUS BY ANOTHER NAME

Premier Li Keqiang said last week the necessary policies were in place and the government would push ahead with infrastructure investment, seen by analysts as a signal of official concern about a slowing economy.

Economists at top government think-tanks believe some of this spending is already under way, as Li had outlined "policy reserves" in a report to parliament last month.

"The top priority is stabilising growth. Policy measures have been prepared and it's just a matter of implementation," said Wang Jun, senior economist at China Centre for International Economic Exchanges.

"The pace of investment and fiscal spending is quickening."

With the economy cooling, weaker and more indebted firms are beginning to feel the squeeze and a Chinese newspaper reported on Tuesday a second case of a domestic bond default in less than a month.

As long as the sums involved and affected companies are relatively small, authorities appear content to let cases like that serve as an incentive for banks and investors to better assess risks.

Beijing's concern is, however, that with a deeper prolonged slump, financial stress could spread undermining confidence in the entire financial system.

The stimulus is expected to be far more targeted and modest than the 4 trillion yuan package during the global crisis in 2008-09, to prevent problems of overcapacity and debt as well as maintaining the government's focus on structural reforms.

"They are doing it quietly. They cannot use the word stimulus, which has become a negative word," said Xu Gao, chief economist at Everbright Securities in Beijing.

Xu expects the government spending will see annual economic growth to rebound to 7.5 percent in the second quarter from his forecast of 7.3 percent in the first quarter.

The government wants to reduce the economy's dependence on exports and enhance the role of consumption, but it is unclear how much growth it might be willing to sacrifice.

"These measures will slow down China's growth in short term, but will make growth more sustainable in longer term," Asian Development Bank deputy chief economist Juzhong Zhuang said at the release of the ADB's 2014 outlook report on Tuesday.

In the report, the ADB lowered its forecast for China's growth this year to 7.5 percent from 7.7 percent earlier.

GRAPHIC: Asia manufacturing PMI (China HSBC): http://link.reuters.com/maz35s

GRAPHIC: Asia manufacturing PMI (China NBS): http://link.reuters.com/baq77s

GRAPHIC: China econ/trade suite: http://link.reuters.com/fut96s

GRAPHIC: China PMI, industrial output: http://link.reuters.com/qaf92t

(Editing by John Mair)