Time to Take China's Official PMIs Seriously

China’s PMIs, compiled monthly by the China Federation of Logistics and Purchasing, are among China’s most useful monthly indicators,  as they are not just timely, but also detailed and plausible both for their internal consistency and because they have a track record of getting major turns in trend right.  Looked at in detail, May’s Manufacturing PMI paint a coherent picture of China’s manufacturers beginning to gear up in response to an improvement in the external trading environment which is nowhere to be found, yet, in other official data. This otherwise hidden upturn shows up dimly but consistently across  export orders, imports, buying of inputs, inventory policies, work backlogs and pricing. 

PMIs are too a good an idea to be left to fulfil their potential. The idea of surveying managers who have to run their businesses responding to perceived short-term changes in the market environment is obviously attractive. If anyone feels the cross-currents of an economy, it must surely be them. They also hold out the promise of producing a speedier verdict on current and near-future market conditions than is possible for the fuller surveys demanded by the production of conventional industrial indicators (eg, industrial output, exports etc).

So when done properly, they are extremely valuable. The best examples come from the US, where the timely ISM manufacturing index and to a lesser extent the extremely timely various regional industrial surveys have earned the right to be trusted.

But problems surface in Europe. There is certainly room for good PMIs in Europe, since official data tends to surface slower than in either the US or Asia, and in certain countries - the UK for example - the official statistics organizations currently seem incapable of generating stable series, even granted the extra time they take to produce them.  A commercial organization, Markit, has encamped on the space vacated by Europe’s official statisticians, and the beginning of every month litters Europe with a confetti of PMIs. To put it mildly, I am sceptical about their worth. I will confine myself to two observations. First, the minute sensitivities suggested by the results (the Eurozone manufacturing PMI, for example, has a standard deviation of only 0.6pts out of 100 during the last 12 months) is undermined by a lack of transparency about they are arrived at. Second, there is no significant statistical relationship between movements in the manufacturing PMI and movements in Eurozone industrial output.

The problems of Markit’s European PMIs tend also to cast a shadow over the credibility of the surveys it constructs in Asia. This is a shame, because in several countries, including India and Indonesia, credible manufacturing PMIs could be very useful.

Some Asian countries produce their own, and of these, there’s no doubt that China’s is potentially the most important. I believe China’s official manufacturing PMI is becoming a genuinely useful tool which provides timely, detailed and plausible information about the state of China’s economy.

The reason why I think China’s official manufacturing PMI should be taken seriously is that the headline figure is accompanied by 12 subindexes covering different aspects of the production phase, and that in the five cases where those subindexes can be checked against subsequently-released industrial data, they tend to tell similar stories. Moreover, those aspects which check out are central to our understanding of China’s industrial cycle: output, exports, imports, inventories and pricing.

First, we can compare the PMI subindex for output with year-on-year movements in industrial output. Since 2012, the changes in the PMI output subindex have generally moved in line with changes in the yoy changes in industrial output. Most recently, since the middle of 2015, the output PMI has signalled growth in output stabilizing at historically low levels. May’s subindex extends this trend, but signals no new deterioration.

The convergence between the export orders subindex of the PMI and actual US$ export growth is less clear, but captures well the deterioration in trading conditions endured since the middle of 2014. Currently, there is a recovery in the export orders PMI emerging that has yet to be seen in China’s raw trade data. 

Much the same can be said of the relationship between the imports PMI subindex and the imports reported in the trade data: there appears to be a general overlap of changes in trend, and currently there is a rise in imports recorded in the PMI subindex which is not yet coming through in the trade data.

When it comes to pricing, the relationship between the input prices PMI subindex and the monthly PPI yoy is much closer: both record the intensification of price deflation seen since the middle of 2014, and both are now signalling a recovery in price pressures since the end of 2015. 

Finally, we can compare the finished goods inventories PMI subindex with changes in inventories of finished goods contained as a line item in the monthly industrial profits data release. Again, the stories they tell mostly complement each other, although over the past few months, the PMI subindex has signalled a modest recovery in inventory-holdings which is not yet showing up in the industrial profits series.  

In none of these cases is the relationship between the PMI subindex and the reported data exact, but in each case it seems that the same trends and changes in trend are captured in both.  Because of that, we should be paying close attention to the official monthly PMIs: they seem genuinely to provide both an early lead on forthcoming data, and another source from which to triangulate other Chinese data.  Moreover, given the difficulties and uncertainties surrounding China’s official data, triangulating for internal consistency is always central to any interpretation of the data. 

In addition, the fact that these subindexes seem reasonably plausible lends credibility to other of the subindexes. This is particularly important because the employment PMI subindexes reported both in the Manufacturing PMI and the Non-Manufacturing PMIs provide practically the only timely and regular pointer to changes in China’s labour market that we have access to. The health of the labour markets is one of the top two economic priorities of China’s policymakers (the other is inflation). As the chart shows, currently these subindexes suggest the declines in the manufacturing sector during 2015 have been moderating since the beginning of the year, whilst employment in the services sector is largely unchanged. The net result suggests that the deterioration in China’s labour markets is moderating, though conditions are not yet improving. 

So what do these official PMIs tell us about the state of China’s economy? May’s Manufacturing PMI was unchanged at 50.1, suggesting nothing better than stagnation - although this is an improvement from the deterioration signalled between August 2015 and February 2016. The non-manufacturing PMI retreated 0.4pts to 53.1, suggesting expansion has slowed towards the lower end of a trend growth seen over the last year.  

The Manufacturing PMI subindexes, however, contain clear positive signals for both exports and imports, and slightly improved signals for both output and inventory policies. This slight improvement also shows up in quite strong upturn in trend for buying of inputs, and a noticeably slower erosion of work backlogs. In addition, there is a clear retreat in deflationary pressures reported since 2H2014.