China's Manufacturing Sector Cracks

The recovery process for the world economy has received a big blow after China's manufacturing sector has seen a contraction for the first time in the last 7 months. HSBC's Flash Manufacturing PMI reading for May 2013 has come in at 49.6 against 50.4 in April 2013, indicating a contraction in the sector. The Flash PMI typically comes in a week before the final PMI for the month.

Following this announcement, Japan's Nikkei tanked 7% by closing on May 23. The Chinese equity markets have turned negative, while both the Indian headline indices are down about 2% as of the time of writing this piece.

The crux of the China data points is that new orders are decreasing in the country. Orders in the export segment are also declining sharply, which would result in a rise in unemployment levels. China is an export giant, and any stresses on this side will do serious harm to the prospects of global recovery.

Due to the bleak business outlook, labour conditions in the country have worsened further. The data compiled by HSBC indicates that the rate of employment is declining faster. The drop in new domestic and export orders will be further detrimental to this situation. The higher unemployment will lead to a decline in consumer demand, and will also hit GDP growth.

On the pricing front, both input costs and output prices have declined. The inventories of finished goods have expanded, while the quantity of purchases has gone down. Both factors indicate that consumers are purchasing less material.

Overall, from this weak data, it is clear that the Chinese economy has slowed down. China’s GDP for the March 2013 quarter was at 7.7%, against 7.9% in December 2012 quarter. In fact, investment bank UBS has downgraded the GDP growth of China to 7.7% in 2013 and its expectations for 2014 to 7.8% on the back of weak economic indicators.

So how does this impact India. According to Dhananjay Sinha, Economist and Strategist at Emkay Global, “The decline in the export orders is likely to spill over to other countries. India's trade deficit has already widened, and weak data means further widening of the current account deficit as well as the trade deficit”. Sinha is also bearish on the rupee, which is trading at the level of 56 against the dollar. He maintains his 2013 forecast of the rupee near Rs 55. In a worst-case scenario, he said that the rupee may touch 60 against the dollar.

In our special report 'Drop Of Oil' (DSIJ Vol. 28, Issue # 12, dated June 2, 2013), we had clearly stated that a lower outlook on crude oil means that equities have to let go of expectations of higher returns. Well, the co-relation seems to be working at the moment.

Ahead today, the PMI data from Europe is expected to come in, which will provide further cues about the global economy. The HSBC India Manufacturing PMI is due on June 3, 2013, and the markets are keenly awaiting this data.