China's official manufacturing PMI fell to 49.2 in August from 50.1 in July and the averaging reading of 51.3 in Q2. It is lower than the consensus estimate of 50 and our expectation of 49.8, and the worst reading since December last year. Taking into account the seasonality (August PMIs were on average 0.6ppts higher than those in July), the underlying momentum is even weaker than suggested by the headline. In light of this official PMI report, the August HSBC PMI (also a decline), and the sluggish DB’s China weekly activity index for the past weeks (no improvement in August), we now believe that August's IP growth will most likely fall below July's 9.2% and be the lowest since May 2009.

 

Among major sub-indices of the official PMI, raw material inventory recorded the largest decrease, by 3.4ppts, to August's 45.1. New orders showed a slight decrease by 0.3ppts to 48.7 and new export orders remained at the low level of 46.6. The production sub-index also fell by 0.9ppts to 50.9. Although the input price sub-index recovered from the July but it remained at a very low 46.1, well below the breakeven level. These inventory and input price indicators suggest that final demand remains sluggish, confidence is low, and the inventory destocking process is still on-going.

 

By sector, the PMI pattern remains largely unchanged: those for consumer goods such as food, tobacco, electronics and garment are above 50, while those FAI- and some export-related sectors such as raw materials, equipment, furniture, and textile remained below 50.

 

The PMI for small businesses (47.7) stayed below 50 for most of this year, and those for large and medium firms fell below 50, to 49.1 and 49.9 respectively, for the first time this year.

 

As for policy outlook, as we pointed in our several recent notes, we do not expect any major policy surprises in the remainder of this year. Several modest actions -- such as one more rate cut, 1-2 more RRR cuts, some modest tax cuts for small/micro firms, an increase in tax rebate for selected exporters, and an interest subsidy for consumer credit -- may be taken by the government but the impact of these policies on the broader economy will be quite limited.

 

In light of these most recent developments, a weaker Q3 (measured by yoy GDP growth) has become more likely than just one month ago, and the chance of modest Q4 recovery is only 50% in our view.