Easing industrial production growth on the mainland is healthy and will help reduce inflationary pressure while still accommodating real GDP growth of more than 9.5 percent in the first quarter.

The growth of the manufacturing sector slowed in February as a result of the lunar new year holiday, the National Bureau of Statistics (NBS) said Tuesday while releasing the latest reading of the purchasing manager index (PMI) that it helps produce with the China Federation of Logistics and Purchasing.

The NBS manufacturing PMI posted an expected drop in February, falling to a six-month low of 52.2, from 52.9 in January. Historically, the NBS PMI exhibits a seasonal pattern and tends to show a month-on-month (MoM) moderation in January-February, associated with cold weather and the Chinese New Year holiday. This is usually followed by a MoM rebound in March-April. Therefore, a modest rebound is expected in the headline NBS PMI in March. The HSBC PMI released on the same day painted a similar picture, declining to 51.7 in February from about 54.5 in December-January.

January-February industrial production growth, which is expected to be released on March 11, is expected to slow, albeit moderately, from the 13.5 percent year-on-year (YoY) increase in December. Looking beyond the seasonal uncertainties, there has been a moderation in underlying momentum since last December from the accelerating pace seen in October-November due to aggressive policy tightening measures. It has featured three benchmark interest rate hikes, five reserve requirement ration (RRR) hikes (as well as differentiated RRR hikes to some 40 city commercial banks), intensive quota controls on bank lending, and intensified tightening in the property sector. As a result of these measures, businesses have been reporting very tight credit conditions, much higher borrowing costs, and surging input costs.

The moderating pace of production activity in the first quarter of 2011 will be healthy and help ease inflationary pressure. But it should still give rise to real GDP growth of more than 9.5 percent YoY in the first quarter. The growth momentum was very strong in the fourth quarter of 2010 (9.8 percent YoY and 11.5 percent quarter-on-quarter), and the economy faced overheating risks adding to the inflation risks from the demand side as shown by the continued pickup in non-food price inflation. Some more interesting questions are: is the economy heading towards a trend slowdown? (I expect a softening quarter-on-quarter momentum during the first quarter to third quarter) To what extent will it slow, given the significant policy tightening, which is expected to remain in place in the first half, and which has changed business and the market's expectations from the third quarter of 2010?

Details of the PMI report showed a marked drop in the output index, to 53.8 from 55.3 in January and 57.5 in December. This is partly related to the Chinese New Year, as well as significant shortages of labor that were reported after the holidays in February (the employment index was steady at 49). The new orders index held up relatively well, slipping to 54.3 from 54.9 in January, and the imports component posted a strong pick-up to 53.9 from 53, suggesting continued robust domestic demand. As expected, the input costs index rose to 70.1 from 69.3, highlighting continued inflationary pressures.

The author is vice president and China economist at Barclays Capital Asia Ltd. The opinions expressed here are entirely her own.

(HK Edition 03/02/2011 page2)