Asian Economies Slowing But Not Derailing

SINGAPORE—Manufacturing activity in much of Asia continued to slow in July, with regional powerhouse China registering its first contraction since its recovery began in early 2009, indicating that the rebound in the world's fastest-growing region is losing steam.

India bucked the trend, with its manufacturing purchasing managers' index, often seen as a proxy for economic growth, rising slightly for a 16th straight month. But declines in PMI readings from South Korea and Taiwan Monday underscored how Beijing's efforts to curb a boom in property prices have affected the rest of Asia, whose export industries have been driven by Chinese demand.

Still, the generally weak readings didn't alarm economists, most of whom have been expecting growth to ease. Moreover, the relatively mild slowdown so far means some Asian central banks—wary of a potential rise in inflation—will likely continue rolling back the extraordinary monetary easing they implemented during the global financial crisis, though some authorities may take a cautious approach in further tightening.

"This indicates a slowdown in the pace of economic growth in Northeast Asia. In the case of China and Taiwan, growth has slowed quite markedly," said Dariusz Kowalczyk, a senior strategist with Credit Agricole.

The HSBC China Manufacturing PMI fell to 49.4 in July from 50.4 in June, the fourth straight month of decline and the first time since March 2009 that the index was below the boom-bust threshold of 50.

PMI is calculated by compiling survey responses of manufacturers who are asked about new orders, inventory levels, production, supplier deliveries and employment. A reading above 50 represents expansion, while any number under 50 means contraction.

Financial markets took the news in stride, as investors had braced for weak PMI readings. Some economists said seasonal factors may have exacerbated the slide.

A different, official PMI for China, issued Sunday, suggested a slightly more modest slowdown in Asia's second-biggest economy. The index, issued by the China Federation of Logistics and Purchasing and the National Bureau of Statistics, fell to 51.2 in July from 52.1 in June, the third straight decline and the slowest pace in the 17 straight months that the index has been above 50.

Hongbin Qu, HSBC's chief economist for China, said Monday's reading also didn't spell doom for China's economy. The drop below 50 in the HSBC PMI suggests that manufacturing continued to decelerate, reflecting the combined effect of credit tightening, property-cooling measures and other steps by Beijing to cut capacity in energy-intensive sectors.

"However, there is no need to panic because this is just a slowdown, not a meltdown," the economist said.

China's trading partners felt the cooler breeze. The Chinese economy's rebound in 2009, driven by massive monetary and fiscal stimulus, helped pull other Asian countries out of deep slumps. With demand in U.S. and European export markets recovering only slowly, Asia's economic prospects hinge on Chinese demand.

HSBC said its Taiwan Purchasing Managers Index fell to 50.5 in July from 53.8 in June, remaining in expansionary territory for a 16th consecutive month but marking the weakest reading since March 2009 because of a fall in demand from overseas customers.

South Korea's economy appeared to be more resilient. The manufacturing sector fell for a third straight month in July, with the HSBC PMI slipping just a tad to 53.2—the lowest level in seven months—from 53.3 in June.

"Korea is hardly stopping for breath. Despite signs of an easing of the global trade cycle, growth momentum going into the third quarter remains robust," Frederic Neumann, co-head of HSBC's Asian economic research, said in a statement.

"Strong growth has led to some pick-up in input costs even as output price pressures remain manageable, suggesting that the central bank may continue to hike rates in the coming months," he said.

Other parts of the Asia-Pacific region also showed strength.

HSBC's PMI for India edged up to 57.6 in July from 57.3 in June. That's likely to keep pressure on the central bank, which has been struggling to tame inflation that the government expects to surge to around 11% in July from 10.55% in June.

"Strong growth... comes at a price: input and output price pressures show few signs of easing. As a result, the central bank will need to apply the brakes more forcefully and dampen demand with further interest rate hikes," Neumann said.

Australia's manufacturing sector also grew faster in July, marking its seventh straight month of expansion, with firmer demand in both mining-related and consumer-driven sectors, according to The Australian Industry Group-PricewaterhouseCoopers Australian Performance of Manufacturing Index. The index rose 1.5 points in July from June to 54.4.

The healthy manufacturing output shows that Australia's economic strength is broadening beyond the mining sector, even as factory owners complain that Australian dollar's high foreign exchange rate is hurting them.

Annette Beacher, a senior strategist at TD Securities, said a lull in inflation in the second quarter reported last week will likely keep the Reserve Bank of Australia on hold for the next few months, though price pressures may build, prompting it to tighten policy in November or December.

Korea received a similarly benign inflation report Monday, with data showing the consumer price index rose 2.6% on year, within the Bank of Korea's 2010 inflation target band of 2%-4% and the same pace as in June. But inflation could pick up to 3% before the year-end, leading the BOK to hike rates again in September, Singapore's DBS Group said.

Elsewhere, however, rising inflation could create more pressure on the central bank to act. In Indonesia, inflation in July climbed to its highest level this year, the Central Statistics Agency said, a development likely to prompt some debate at Bank Indonesia's Wednesday policy meeting. The Consumer Price Index–an indicator that tracks the price of a basket of basic goods–rose 6.22% in July from a year earlier, faster than the gain of 5.05% in June and above a median forecast for a 5.66% rise in a poll of 10 economists by Dow Jones Newswires.

Most analysts have expected Bank Indonesia, which has held its benchmark rate at a record low of 6.5% since August 2009, to stand pat this week, but the higher-than-expected inflation raises the possibility that the central bank may start tightening.

"Year-end inflation will likely be above the government's upper range of 4%-6%. This certainly opens the door for a rate hike... Bank Indonesia may even start hiking this week," said Eric Sugandi, an economist at Standard Chartered said.

Thailand's CPI rose 3.4% in July from a year earlier, a touch faster than the 3.3% increase in June but below the 3.55% rise that was expected by economists surveyed in a Dow Jones poll. Core CPI, which strips out energy and food costs from the index, rose 1.2% from a year earlier, within the central bank's 0.5%-3.0% target range.

Capital Nomura Securities' economist Nuchjarin Panarode said the Bank of Thailand is likely to hike interest rates at its three remaining meetings this year.

"The central bank has reasons to hike its rate, as the economy is growing while its policy rate is at ultra-low levels," she said.

J.P. Morgan economist Matt Hildebrandt said Monday's PMI data drive home the message that Asia's spectacular recovery from the global financial crisis is probably over, though "there's no reason to think there will be a double dip in the region."

Many central banks, including those in Korea, Thailand and Taiwan, have been looking to adjust monetary policy away from crisis-fighting settings. But Hildebrandt said they may be more cautious as the economic rebound slows.

"We will have less growth going forward, less aggressive tightening," he said.