China manufacturing contracts in July as orders cool, flooding disrupt businesses

Activity in China’s manufacturing sector eased unexpectedly in July as orders cooled and flooding disrupted business, an official survey showed, adding to fears the economy will slow in coming months unless the government steps up a huge spending spree.

While a similar private survey showed business picked up for the first time in 17 months, the increase was only slight and the much larger official survey on Monday suggested China’s overall industrial activity remains sluggish at best.

Both surveys showed persistently weak demand at home and abroad were forcing companies to continue to shed jobs, even as Beijing vows to shut more industrial overcapacity that could lead to larger layoffs.

And other readings on Monday pointed to signs of cooling in both the construction industry and real estate, which were key drivers behind better-than-expected economic growth in the second quarter.

The official Purchasing Managers’ Index (PMI) eased to 49.9 in July from the previous month’s 50.0 and below the 50-point mark that separates growth from contraction on a monthly basis.

Analysts polled by Reuters predicted a level of 50.0.

While the July reading showed only a slight loss of momentum, Nomura’s chief China economist Yang Zhao said it may be a sign that the impact of stimulus measures earlier this year may already be wearing off.

That has created a dilemma for Beijing as the Communist Party seeks to deliver on official targets, even as concerns grow about the risks of prolonged, debt-fueled stimulus.

“The government has realized the downward pressure is great but they’ve also realized that stimulus to stimulate the economy continuously is not a good idea and they want to continue to focus on reform and deleveraging,” Zhao said.

Heavy flooding, particularly along the Yangtze River, contributed to July’s manufacturing contraction along with slowing demand and the cutting of overcapacity in some industries, the statistics bureau said.

Falling activity at smaller firms also was a key reason for July’s poor figure, the statistics bureau said, but performance at larger companies improved, in a sign that the government is becoming more reliant on big state firms to generate growth.