China Feb factory activity shrinks more than expected, layoffs on the rise

Activity in China's manufacturing sector shrank more sharply than expected in February, surveys showed on Tuesday, prompting smaller companies to shed workers at the fastest pace in seven years and suggesting Beijing will have to ramp up stimulus to avoid a deeper economic slowdown.

Some investors had been bracing for weak readings after the central bank unexpectedly eased policy late on Monday, injecting an estimated $100 billion worth of cash into the banking system to cushion the pain of upcoming reforms such as restructuring bloated state enterprises.

The official Purchasing Managers' Index (PMI) fell to 49.0 in February from January's reading of 49.4 and below the 50-point mark that separates growth from contraction. Economists polled by Reuters had expected only a slight dip to 49.3.

It was the lowest reading since November 2011.

"The PMI came in much weaker than markets expected, hinting that recent easing measures have had limited impact in turning around the weakening manufacturing sector," wrote senior emerging markets economist Zhou Hao at Commerzbank in Singapore.

"We think PBoC will cut policy rates by 25 basis points in the first quarter and lower RRR (banks' reserve requirement ratio) by another 100-150 basis points this year."

The private Caixin/Markit China Manufacturing Purchasing Managers' Index (PMI), which focuses more on small to medium- sized, private firms, showed activity contracted for a 12th straight month. It fell to 48.0, below market expectations of 48.3 and January's reading of 48.4.

Both surveys showed conditions in China's job market were continuing to deteriorate, challenging policymakers who are finalising Beijing's next five-year development plan ahead of the annual parliament meeting starting on March 5.

The Caixin report showed companies shed jobs at the fastest pace since January 2009, when China and other trade-reliant economies were reeling from a near-collapse in global trade following the financial crisis.

Firms that reported lower headcounts cited company downsizing and cost-cutting, and said more workers who were leaving voluntarily were not being replaced. The employment sub-component of the index fell to 46.0 from January's 47.0.

The official PMI survey, which tends to focus on larger, state firms, has shown persistent declines in employment for the last 3-1/2 years.

To be sure, although Markit adjusts figures for seasonal effects, the timing of the long Lunar New Year holiday can make Chinese data in January and February difficult to interpret. Economic activity slows dramatically around the holiday, which falls on a different date in late winter every year.

Still, the findings in the latest surveys have dashed hopes that a year-long blitz of stimulus measures would start to produce signs of economic stabilisation early in 2016.

China's factory sector has been under pressure from weak demand at home and abroad and massive overcapacity in key industries such as steel and coal, diluting the impact of six central bank interest rate cuts and a spate of other support measures since November 2014.

Industrial profits fell 2.3 percent in 2015 after rising 3.3 percent in 2014.

Both surveys on Tuesday showed further contractions in domestic and export orders, suggesting industrial output will remain sluggish in coming months.

In addition, some manufacturers in capital-intensive sectors are struggling with heavy debt loads, which are becoming increasingly difficult to repay as they have to constantly cut prices to win sales. Last year witnessed a rash of bond defaults by steel, cement and chemical firms. Chinese factory gate prices fell for the 47th straight month in January.

The government has made cutting overcapacity in steel and other "old economy" sectors a priority this year, though previous efforts have run into strong resistance locally as big firms are often a key source of tax revenue and employment.

China said on Monday it expects to lay off 1.8 million workers in the coal and steel industries, or about 15 percent of the workforce, but no timeframe was given.

Recent tax changes have also raised concerns that China hopes to export more of its excess industrial capacity abroad, further worsening global gluts of chemical and steel products and effectively exporting deflation abroad.

China's economic growth cooled to 6.9 percent in 2015, the slowest pace in 25 years, and economists see it slowing further to around 6.5 percent this year. Some market watchers believe it is already much weaker than official data suggests.

Services softening?

A growth slowdown in China's services sector last month was also singled out by analysts as a cause for concern.

The official non-manufacturing PMI fell from 53.5 in January to 52.7 in February, still in expansion territory but the weakest reading since late 2008.

The services sector has been taking up an increasing amount of economic slack as manufacturing cools, but analysts have wondered how long it can remain resilient in the face of the prolonged factory slump and increasing unemployment.

With manufacturing in both a cyclical and structural funk, Beijing has been keen to grow the services sector and make consumption a stronger driver of the economy.

"Today's data suggest that policy makers will take further measures in the upcoming National People's Congress in order to achieve a GDP growth target of 6.5 to 7 per cent in 2016," ANZ economists said in a note.

"A proactive fiscal policy will be needed to support investments and we expect the fiscal deficit could be increased to a range of 3-4 per cent in 2016, from 2.3 per cent in 2015" in order to boost government spending.

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