China’s Industrial Dragon Burning Less Hot

China’s growth started showing signs of strain in July

By Nathaniel Taplin

  A man with a kite shaped like the symbol of China's People's Liberation Army poses in front of Shanghai’s Pudong financial district on July 27. Photo: aly song/Reuters

China is in the midst of a historic summer heat wave—temperatures in Shanghai hit their highest in 145 years on July 21. However, the country’s economic growth, which surprised on the upside in the first half of the year, is suddenly looking less hot.

China’s official factory and services sector gauges both ticked down in July—the first concerted decline since April, although both indexes remained in positive territory. More important, the purchasing managers’ indexes contained hints that two of the most bullish factors for Chinese growth in recent months—fat industrial margins and strong exports—may be waning.

The new export orders PMI subindex fell by 1.1 points to 50.9, its sharpest drop since late 2014. That’s worrying because the turnaround in export growth has been one of the main factors painting a brighter picture for China this year. As recently as March 2016, falling net exports were subtracting nearly a percentage point from the annual growth rate. However, by early 2017 the global recovery in trade was adding nearly half a percentage point instead.

If China’s July trade data confirms the latest weakening trend, downside risks in the second half will increase.

The sharp rise in factory input costs and a much weaker gain in sales prices imply that margins probably weakened in July after months of expansion, which drove industrial profits up 19% from a year ago in June.

The factory-gate price index rose 3.6 points, but the input price index rose nearly twice as fast, and hit its highest level since March. Rapidly rising steel prices may be one factor—China’s statistics bureau noted that both input and output prices rose rapidly in the iron-and-steel sector in June. Downstream companies in machinery and other industrial sectors will start to feel the pinch.

On the whole, July’s PMI shows the economy still in good health—but if margins keep eroding and exports slow further, the picture could darken in late 2017 or early 2018.

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