What China’s Manufacturing Slowdown Means for the World Economy

China manufacturing slowdownOn Monday, May 4, 2015, HSBC released its China Manufacturing PMI for the month of April. The index is down to 48.9—the lowest in the previous 12 months. Moreover, the drop is also the sharpest it’s been in a year. (Source: HSBC/Markit, May 4, 2015.)

Purchasing Managers’ Index, or PMI, is an indicator of the economic health of the manufacturing sector. It is based on five individual indicators: new orders, output, supplier delivery times, inventory, and employment. A PMI of above 50 indicates an expansion of the manufacturing sector, whereas below 50 signifies a contraction.

Weak Domestic Demand, Struggling Manufacturing Sector

Looking at the data, April’s PMI of 48.9 and March’s 49.6 suggest that Chinese manufacturing has been contracting for two consecutive months. The report by HSBC shows a decline in new orders at Chinese manufacturers, caused by weaker domestic demand.

Purchasing activity also shows signs of weakness by declining for the first time since January of this year. The decline was also the sharpest over the last 12 months. This is also due to the drop in new orders. As a result, inventory levels plunged as well.

The Chinese manufacturing sector is facing deflationary pressures; the average input cost faced by producers in China has been falling for nine consecutive months. On the output side, manufacturers responded with lower selling prices.

Employment is suffering as well; manufacturing employment has been contracting for 18 months.

Manufacturing is not the only sector that is struggling in the Chinese economy. The property market is cooling down, domestic demand is weak, investment is slowing down, and debt is high. All of these factors depict a contracting economy.

Alert World Economy: China is Slowing Down

China is not an island isolated from the global economy. It is the second largest economy in the world according to the International Monetary Fund (IMF). It is also the U.S.’s largest trading partner. An economic slowdown will send waves of uncertainty around the globe. (Source: IMF, last accessed May 4, 2015.)

China does a significant amount of manufacturing for foreign companies, including ones from the U.S. The slowing down of its manufacturing sector shouldn’t worry just Chinese companies, but also businesses around the world.

Moreover, many U.S. companies are targeting the growing middle class in China. These companies include McDonald’s Corp. (NYSE/MCD), Starbucks Corporation (NASDAQ/SBUX), The Gap, Inc. (NYSE/GPS), and Ford Motor Co. (NYSE/F). Their success in China depends on whether the growing middle class has enough disposable income.

With no good social welfare program in sight, the majority of Chinese workers are still saving for their retirement, with the average household saving 30% of its disposable income. This puts significant constraints on domestic demand. Weak demand slows down the country’s manufacturing sector, and the growth prospects of foreign businesses in China remain gloomy. (Source: Federal Reserve Bank of San Francisco, last accessed May 4, 2015.)