China Research

PMIs (Purchasing Manager Indices) use to be interesting readings. PMIs have three advantages.

First, they are the fastest of the published short-term business-climate indicators. They are published for manufacturing – which is the most important one – and services just a few days after the surveys have been concluded and only around two weeks after the questionnaires have been sent to the purchasing managers. Second, purchasing managers operate quite early in the planning and production cycle of a company which gives them a “competitive analytical advantage”. Third, purchasing managers are usually very skilled also what concerns the business climate in different sectors and countries – both in an aggregated and an individual corporate perspective. This broad analytical approach is necessary to manage successful price negotiations. This assumes knowledge about price and wage trends, currencies, etc., too.

I feel safe in these conclusions since I introduced the PMI via SILF/Swedbank in Sweden myself almost twenty years ago – roughly at the same time as the UK did (which meant that the UK and Sweden were the first countries outside the U.S. to produce the PMI numbers for manufacturing). Now the PMI can be found in almost 40 countries, China included.

China even has even two PMIs. One – the official one – is produced by the China Federation of Logistics & Purchasing (CFLP), the other one by the large financial institution HSBC in co-operation with the research house Markit in the UK. Usually, these two indices do not have exactly the same numbers for the same month. Sometimes, directions may be even (somewhat) different. During the roughly eight years of their common existence, the HSCB PMI tended to give somewhat lower numbers than the index prepared by the CFLP (however less obviously in the past few years).

These statistical differences may have several reasons. For example, the number of participating companies in the CFLP survey nowadays is almost four times larger than the one of the HSCB PMI (which is not necessarily related to quality). It can also be added that the HSCP index seems to be more sensitive to changes in the exporting manufacturing sector. Other comments I have heart from Chinese and other economists point at weaker seasonal adjustment systems in the PMI system of CFLP. In my opinion, it could even be a mix of all these – and other – explanations. Transparency is simply too low in this respect.

Altogether: it is hard to really judge the quality of the two PMI indices. Despite certain shortcomings, they probably still deserve the reputation of being the best short-term industrial climate indicators in China (and many other countries). Unfortunately, financial markets so far have not always understood what PMIs really are all about. This includes the understanding of China’s PMI.

Five types of misunderstandings happen very frequently in this index system where a composite index below 50 is defined as a location in the declining area of industrial activity and above 50 as a result that indicates production growth in manufacturing.

–  Smaller deviations between result and expectations/predictions – for example, 49.4 compared to 50.1 – can be often practically very irrelevant even when financial markets at the same time express strong initial disappointment. The “50-points limit” should not be treated as an exact borderline between positive and negative industrial growth (yes: economists use the term “negative growth”).  Not in China either. In some countries, it is even discussed whether the borderline of index 50 still is valid or if another index number defines the growth and recession areas in industry more precisely.

–  The PMI is a diffusion index. This means that a relative limited number of purchasing managers who changed their current opinion on the PMI’s sub-indicators just a little bit compared to the previous questionnaire may affect the PMI number with 0.6 or 0.7 points. Deviations of this limited size may be (occasionally) given too much attention by financial analysts and the press.

–  The PMI does not say anything about the strength of the changes. A (slightly) falling PMI number may in reality be much less alarming if the negatively answering companies only have been affected by very small downturns in, for example, new orders, production or employment (the same can be concluded when index numbers move in the other direction). Again: the PMI does not register the magnitudes of changes during the past month.

–  PMI numbers should not only be examined on a monthly basis. When I prepared the monthly PMI index and reports on behalf of SILF and Swedbank until 2008, I always made graphs for three/six months moving averages as well. This kind of exercise made the PMI graphs (somewhat) less volatile and my own reactions many times more relaxed.

–  Thus, too little emphasis is usually given to somewhat more historical studies. Comparisons with the same month one year ago may be quite useful. Such an easy approach makes the analysis of current index levels somewhat easier to interpret.

To summarize: China’s PMIs may have weaknesses – also when it comes to parts of methodology and transparency (but one can observe these kinds of shortcomings in other countries as well). Monthly PMI numbers should get somewhat less focus than it is nowadays often is the case. The use of moving averages could be preferred in certain applications. But the PMI still tells us quite a bit about the temperature in the industrial (and service) sector. That’s why it is important. This is true of China, too.

Hubert Fromlet
Professor of International Economics
Editorial board

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