MNI CHINA ANALYSIS:PMI Divergence Points to Small Firm-SOE Gap

     BEIJING (MNI) - The two main Chinese purchasing managers' indexes (PMI)

stood in stark contradiction to each other in September, a possible indication

that small and medium-size private companies face a long, cold winter while

their larger, mostly state-owned siblings, helped along by the government's

supply-side reforms and campaign to eliminate industrial overcapacity, will see

smooth sailing ahead. 

     The government's official PMI, jointly released by the China Federation of

Logistics and Purchasing (CFLP) and the National Bureau of Statistics, jumped to

52.4 in September from 51.7 in August, reaching its highest level in five years.

The Caixin manufacturing PMI fell to 51.0 from 51.6 in August, the weakest level

since June, according to data compiled by IHS Markit.

     The official PMI samples 4,000 large-size manufacturing enterprises in

China, while the Caixin PMI samples about 400 manufacturers and is more volatile

than the official PMI because of its smaller sample size and greater emphasis on

smaller and medium-size manufacturers.

     The official services PMI and Caixin services PMI also diverged, with the

former rising to 55.4 in September from 53.4 in August, while the latter dropped

to 50.6 in September, down sharply from 52.7 in August and the weakest reading

since 50.2 in December 2015.

     In general, both PMI indexes are seen as leading indicators because they

reflect China's economic performance in a comprehensive and objective manner,

and they both include sub-indexes monitoring output, prices, inventories and

demand. 

     But the wide split between the two indexes in September is confusing. 

     The official index showed solid momentum, prompting government officials to

say that domestic and overseas demand is improving, China's industrial structure

is optimizing and new drivers for economic growth are forming.

     The Caixin index told a different story: As both the manufacturing and

service sectors are suffering, economic slowdown pressures could become evident

as soon as the fourth quarter. 

     The wider market consensus seems to be that slowdown pressures are in fact

coming, particularly after two consecutive quarters of unexpected 6.9% GDP

growth and likely strong growth again in the third quarter (Q3 GDP will be

released Oct. 19). The overly rapid surge of raw material prices, sluggish

property sales and growing fiscal deficit also indicate a more pessimistic

scenario. But there is evidence pointing in the other direction, including

robust credit and investment growth. These differences are reflected in the

readings of the two PMIs, mostly through the composition of the participants in

each survey. 

     "Small and medium-sized manufactures have been largely [negatively]

impacted by supply-side reforms, including excess capacity removal and

environmental protection [measures]," Shen Minggao, chief economist at Guangfa

Securities, the fourth-largest brokerage in China, told MNI in explaining the

drop in the Caixin PMI. "In addition, the tight financial environment under the

stricter regulations has also put pressure on smaller companies."

     "As to the drop of the Caixin services PMI, I think it was due to the

slowdown of the property sector," Shen noted.

     "The official PMI is usually stable, while the Caixin one is more variable

due to the above reasons. In this case, the Caixin PMI could reflect economic

changes [are happening] at a more flexible pace," Shen added.

     For small private companies with weaker transfer pricing capabilities than

big SOEs and corporates, the surging prices of raw materials that have largely

come as a result of overcapacity cuts have impacted profits, particularly for

those companies operating downstream. In contrast, big companies, particularly

SOEs, have shown solid profits and momentum, providing strong support to the

economy.

     But how long the official PMI can continue its surge remains an open

question.

     Liu Xuezhi, a macro-economist at Bank of Communication, told MNI that

despite the stellar reading of the official PMI in September, "there is more

pressure to maintain the good performance like that in the first half of the

year because the high official PMI was largely boosted by rising input and

output prices, which are not sustainable." 

     What is more, because companies surveyed in the Caixin PMI survey are

mostly export-oriented firms in east coast cities, the index usually edges down

when exports soften, as they did in September. In August, when exports surged,

Caixin's headline manufacturing PMI reached 51.6.

     Although little information has been unveiled on who the participants in

the two PMI surveys actually are, Xie Yunliang, an analyst at Guotai Junan

Securities, told MNI that when the two indexes diverge, as they did in

September, "the official PMI usually fluctuates in the same direction as

industrial value-added, meaning big enterprises with revenue from their main

businesses of over CNY20 million [annually], while the Caixin PMI would

correlate with fixed-asset investment" by mostly privately held companies.

     With the divergence of outlooks between big, mostly state-owned companies

and small and medium-size private ones, the split in PMI outlooks could continue

for the rest of the year.

     "As measures of supply-side reform progress, the concentration of

industrial sectors would be further enhanced, so the performance of different

sizes of companies would diverge further if the current influential elements"

remain unchanged, said Shen of Guangfa Securities.

     One policy change that could help the smaller firms included in the Caixin

survey is the recently passed targeted reserve requirement ratio cut for banks,

which is intended to encourage more lending to smaller companies and energize

the lackluster private sector. But Shen warned that any positive effect for

small firms from the RRR cut could be offset by even stronger supply-side

reforms, which would further cut into small companies' bottom lines. 

     But whether the government takes the step to enhance supply-side reforms

won't be known until after the 19th Communist Party Congress that starts next

week, Shen said.

--MNI Beijing Bureau; +86 (10) 8532 5998; email: marissa.wang@marketnews.com

--MNI Beijing Bureau; +86 (10) 8532-5998; email: vince.morkri@marketnews.com

--MNI BEIJING Bureau; +1 202-371-2121; email: john.carter@mni-news.com

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