China June factory activity still weak but shows some signs of stabilising

PMI edges up to 49.6, a three-month high, from 49.2

China's factory activity showed some signs of stabilising in June but still contracted for the fourth straight month, according to a preliminary private survey, suggesting more stimulus measures may be needed to support the world's second-largest economy.

The HSBC/Markit Flash China Manufacturing Purchasing Managers' Index (PMI) edged up to 49.6, a three-month high, from 49.2, but remained below the 50 mark which separates contraction from expansion.

New orders returned to positive territory at 50.3 and new export orders fell at a much slower pace, but companies stepped up layoffs, shedding jobs at the fastest pace in over six years, a trend which is sure to alarm Beijing.

Factories were also forced to cut prices for their products more deeply, pressuring profit margins.

"On one hand, the sector shows signs of improvement as output stabilised amid a slight pick up in total new work, while purchasing activity also rose slightly over the month," said Annabel Fiddes, an economist at Markit.

"On the other hand, manufacturers continued to cut staff. This suggests companies have relatively muted growth expectations .... and suggests that authorities may step up their efforts to stimulate growth and job creation in the second half of the year."

STIMULUS

Despite a flurry of stimulus and easing measures over the past year, economic growth slowed to a six-year low of 7% in the first quarter and analysts believe further momentum was lost in April-June.

Sluggish demand at home and abroad has left many factories, particularly in heavy industries, laden with overcapacity.

The PMI reading follows small signs of recovering demand, reflected in other private surveys and in public statements by officials, but China is still struggling to get monetary easing to translate into investment in growth.

Part of the problem is that central bank moves to add liquidity into the system are being absorbed by a stock market rally that began in November, and now by the bond market, which is being force-fed a massive plate of municipal bonds being issued as part of a debt swap programme. 

But a toxic combination of conditions have combined to discourage the investment in "the real economy" that Beijing wants to jump-start a turnaround.

Because end-demand remains weak, returns on investment are low in the near- to mid-term. And because the cost of long-term credit remains far higher than capital returns, there's little incentive for executives to borrow.

"Real interest rates are double digits, 11 or 12%. This is the real issue for the economy. You can cut nominal rates to zero and you are still seeing real rates around 5%. The profit margin is only around 3-4%," said Zhou Hao, economist at ANZ Bank in Shanghai.

"We are still seeking new engines for the economy. Basically we need to deleverage first," he said, adding that the recent stock market rally was being used by many executives to retire outstanding debt.