China’s factory activity declined more than expected in October to shrink for a second month, hurt by persistently high raw material prices and softer domestic demand, signaling more economic distress in the final quarter of 2021, Reuters reported.

Sign of stagflation

Data from the National Bureau of Statistics (NBS) showed on Sunday that the official manufacturing Purchasing Manager’s Index (PMI) was at 49.2 in October, down from 49.6 in September.

The 50-point mark distinguishes growth from contraction. Analysts had expected it to come in at 49.7.

In line with the softer headline PMI, a sub-index for production slid to 48.4 in October from 49.5 in September. In addition, a sub-index for new orders also fell for a third month, coming in at 48.8.

More worryingly, a sub-index for output prices climbed to 61.1, the highest since 2016 when the statistics bureau started publishing the indicator, signaling rising inflationary pressures while broader economic growth slows, Reuters added.

“The production index has dropped to the lowest level since it was published in 2005, excluding global financial crisis period in 2008/09 and the COVID outbreak in Feb 2020,” said Zhiwei Zhang, chief economist at Pinpoint Asset Management.

“The output price index rose to the highest level since it was published in 2016. These signals confirm that China’s economy is likely already going through stagflation.”

Causes of China’s economic slowdown

Asialyst reported that Chinese GDP growth also fell to 4.9% in the third quarter of 2021, well below experts’ expectations and the worst performance in years, and there are several reasons for this slowdown.

First, an electricity shortage has forced several provinces to impose rationing, causing power cuts in homes and factories. Among the affected factories are those producing cement, steel, and aluminum, which are particularly important to the country’s economy. 

In addition, the real estate scandal caused by the debt-laden Evergrande and several other major developers of the country fuels the fear of seeing the real estate bubble explode, with risks of domino effect to other sectors of China’s economy. 

Meanwhile, coal production has dropped dramatically due to record flooding in Shaanxi Province, which alone produces 30% of the nation’s fuel. The authorities had also decided to reduce the coal production of large power plants to reduce greenhouse gas emissions.

Which policies are needed?

Analysts polled by Reuters expect the People’s Bank of China to refrain from attempts to stimulate the economy by lowering the cash reserve banks must maintain until the first quarter of 2022.

“Production remains weak, indicating the demand problem may be relatively large, and some easing of policy is still needed,” said Zhou Hao, senior economist at Commerzbank.

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