China Macro: Services PMI sharply down on zero tolerance towards delta – China’s official PMIs for August published by NBS brought further confirmation that the impact of zero tolerance policy towards delta flare-ups is having a strong impact on economic activity, particularly on services.

The non-manufacturing PMI dropped much sharper than expected – by almost 6 points, to 47.5 (July: 53.3, consensus: 52.0) – falling back to below the neutral 50 mark for the first time since February 2020 when the initial Covid-19 shock hit. This is largely due to the stringent mobility measures and regional lockdowns imposed following the latest delta outbreak end July.

The impact of these measures was already visible in weak July activity data, particularly retail sales. We expect China’s services PMI(s) to bounce back later this year, as the success of this policy in containing the latest outbreak will facilitate an easing of restrictions. That said, the Chinese economy (and services in particular) will remain susceptible to virus flare-ups.

While China has ramped up its vaccination roll-out and around 64% of the population is now fully vaccinated, the combination of more contagious variants and the use of vaccines that do not offer full protection means that ‘herd immunity’ is not yet within reach.

All in all, in case of new outbreaks the authorities will likely stick to their targeted, zero tolerance policy aimed at eliminating all cases (see for more background the China part in our latest Global Monthly here)..

Industry feels the impact of bottlenecks. Meanwhile, China’s manufacturing PMI continued its gradual decline, falling to 50.1 (July: 50.4, consensus: 50.2), so close to but still slightly above the neutral 50 mark. This also was the weakest reading since February 2020.

This partly reflects the impact of delta related restrictions such as
the two weeks’ partial closure of China’s one but largest container port hitting export capacity. The official manufacturing PMI’s sub-index for exports dropped to a 14-month low of 46.7 in August. Other bottlenecks include a scarcity in semiconductors, which is hitting for instance the production of cars. There is also the impact of environmental regulation, with for instance the PMI for the steel industry falling to a 1.5 year low of 41.8 in August.

All of this takes place against the backdrop of a credit cycle that has already turned and a regulatory crackdown that has broadened in scope from fintech to sectors such as online education and entertainment.

On the policy front, following the recent slowdown the PBoC already shifted back to “piecemeal” easing, by cutting banks’ RRRs by 50bp in July. We expect modest RRR cuts going forward, but not an aggressive easing cycle given that Beijing will likely stick to the goal of containing overall leverage.

A moderate fiscal response is also likely. All in all, despite these piecemeal easing moves, risks to our annual growth forecast for 2021 (9.0%) are now clearly tilted to the downside.