CLSA: China manufacturing price will have to rise

According to CLSA’s latest Purchasing Manager Index (PMI), Chinese manufacturing firms are having a very good time:  production up, employment up,  incoming business up, new export orders up, backlogs of work up, stock of inventory down. China is (over) heating!

The overall effect for foreigners however is that consumer price and interest rate will move up inevitably in the next several months. I am not sure whether this will continue for ever; based on estimated capacity of power plants and steel mills under construction, in 2007 both electricity and steel capacity in China will exceed demand (currently there is a shortage of both) and the trend of rising input costs is likely to slow down.

According to the CLSA report:

“Production rose for a sixth consecutive month in May, at a rate close to April’s eleven-month high. Output was led higher by increased volumes of incoming new business, which rose at the strongest rate in thirteen months. New order gains were driven by robust demand from both domestic and foreign clients. Growth of new export orders accelerated to the sharpest for twelve months during May.

     Backlogs of work rose for the third consecutive month, with the rate of growth picking up to the sharpest since last December. A number of firms met increased sales from warehouse inventory, contributing to further contraction in stocks of finished goods.

     Latest data highlighted a rise in employment at Chinese manufacturing firms for the second month running in May, though the rate of hiring remained only marginal.

     The quantity of inputs purchased by firms continued to rise in May, with the rate of growth quickening for the fourth straight month to its strongest since April 2005. This contributed to a further expansion of pre-production inventories. Supplier lead times were found to have lengthened slightly for the fourth consecutive month in May, reflecting stronger demand for inputs.

     The rate of input price inflation in the Chinese manufacturing economy surged from April’s already strong pace to a fourteen-month high in May, as 44% of panellists signalled a rise in their average purchase costs since the previous month. Firms widely reported higher prices paid for oil and related products, as well as chemicals and metals.      In order to offset rapidly rising input costs, manufacturers raised their charges again in May. The rate of output price inflation was robust and the sharpest since March 2005, but was still well below that of input prices, reflecting intense competition in a number of markets. This suggests a further squeeze of profit margins.”