The NBS manufacturing PMI rose to 50.5 in January (BarCap: 49.5; Bloomberg: 49.6) from 50.3 in December. It defied the usual seasonal decline in the month of the Chinese New Year (CNY) and posted an upside surprise for a second month in a row.

Despite weakness in the export orders and imports sub-indexes, overall, we think the NBS PMI report reflected strength in domestic demand and provides comfort about the extent of the expected growth moderation in Q1. In our view, the upside surprise also suggests the stronger-than-expected momentum seen in the December data is not temporary or driven solely by seasonal factors (ie, earlier CNY holidays), but reflects the impact of earlier selective monetary easing and proactive fiscal policy and, hence, could be sustained. We see a small upside risk to our 8.1% full-year GDP growth forecast.
 
The detailed PMI report shows that activities remained strong in January and that domestic demand is holding up despite weakness in the external demand. The new export orders index fell to 46.9 from 48.6 in December (November: 45.6), likely reflecting holiday effects given the January timing of the holidays. A similar factor likely weighed on the import index, which fell to 46.9 from 49.1 in December and 47.3 in November. Although the decline in the import index is concerning, we think a better reading is obtained by averaging the January and February data. In contrast, the PMI new orders index rose to 50.4 from 49.8 in December and 47.8 in November, reflecting strength in domestic demand, in our view. The production index also edged up, climbing to 53.6 from 53.4 and suggesting some stabilisation in industrial activity as shown in the December data. New CNY loans in January likely will come in at or above CNY1trn, a level that would have lent support to industrial activities. Meanwhile, input cost index came in at 50, from 47.1 in December.
 
On the policy outlook, our view remains that the PBoC will maintain its "prudent" monetary policy stance for now, while watching for downside risks to growth. In our view, proactive fiscal policy will play a bigger role in supporting growth, if needed. We continue to believe three to four RRR cuts are needed to fine-tune system-wide liquidity in 2012 and expect a 50bp cut in banks' required reserves in February. By our estimate, existing OMO transactions point to a net withdrawal of CNY171bn from the banking system in February. Moreover, we forecast a trade deficit in Q1 and believe capital outflows are likely to persist for some time. We reiterate that reductions in the RRR will be used as a liquidity management tool by the PBoC, and the number and timing of RRR cuts will depend on overall liquidity (affected by FX flows, including the trade balance; the amount of open market operations, including maturing bills and repos; fiscal deposits; etc) and demand conditions.


source: BarCap