Tightening bites: China’s Flash Manufacturing PMI drops to 48.9 in July

July's flash PMI fell below 50 for the first time in a year, reflecting slower manufacturing growth momentum and implying that June's industrial production rebound was temporary. We expect industrial growth to decelerate in the coming months as tightening measures continue to filter through. That said, resilient consumer spending and continued investment in ongoing mass infrastructure projects should support a GDP growth rate of almost 9% for the rest of this year.

Facts
At 48.9, China's headline flash manufacturing PMI fell below the 50-neutral line for the first time since July 2010. Readings declined across the board, including a 1.2 percentage point drop in the headline PMI index, driven by a 2.7ppt decline in the output sub-index to 47.2, the lowest since March 2009.

Production growth slowed largely because of cooler domestic demand. The new orders sub-index contracted for the first time since July 2010, printing 49.5 in July vs. 50.4 in June. The new exports orders sub-index improved slightly from previously, but stayed below 50 for the third straight month at 48.4. Together, both readings suggest that new business flows are slowing not only because of weakness in external but also domestic demand. The latter can be attributed to the continued filtering through of Beijing's tightening measures.

Inventory-wise, stock of finished goods fell at a slower pace, recording 47.9 in July compared to 46.7 in June. Stocks of purchases however hit the lowest level since April 2009 from 48 in June to 45.2 in July, as purchases declined for the second straight month in response to lengthening supplier delivery times.

As a result, new export orders minus inventory (finished goods) ratio yielded its weakest reading in a year, of 1.5, compared with 3.7 in June. Lackluster manufacturing activities, in turn, translated into a marginal deterioration of hiring activities, seeing the employment sub-index stay below 50 for the second consecutive month - 49.4 in July vs. 49.8 in June.

Output prices continued to ease in July, when its sub-index fell to 50.8 from June's 51.1, below the series' long term average of 53.4. July's input cost sub-index also stayed far below its long-term average of 60.2, at 54.5. A slower pace of output price inflation despite a slight pick up in input price inflation could add pressure upon manufacturer profit margins. But from Beijing's viewpoint, it is an encouraging sign that non-food inflationary pressures are starting to recede.

Implications
Market attention will likely revolve around growth after today's release. Does the below-50 reading of PMI, if confirmed in the final PMI result due on 1 August, imply a hard landing for China? No, because as history's shown before (e.g. July 2010 when the PMI printed 49.4), a marginally below 50-reading is still fully supportive of an industrial production growth rate of around 13%. The material upside surprises in both June's IP and electricity growth attest to this.