Chinese factories humming doesn’t mean everyone is buying

CHINA’S factories are starting to hum again, but executives are now worried that the rebound could falter on weak demand at home and abroad.

Justin Yu, a sales manager at Zhejiang-based Pinghu Mijia Child Product Co. that makes toy scooters sold for American retailers, is among those seeing their order book improve from the depths of the coronavirus lockdown, but remain well below normal.

“We are seeing more orders coming in this month as we get closer to our normal peak season,” Yu said. “But our orders are still 40-50% lower than last year.” The factory’s production capacity is running at about 70% to 80%, and Mr. Yu is making to order to avoid any build up in stock.

The disconnect between China’s recovering production and still dormant demand had shown up in data revealing a rise in inventories, though the latest figures show that easing. The worry remains that sustained overproduction will lead China’s factories to keep cutting prices, compounding global deflationary headwinds and worsening trade tensions, before they eventually cut back on production and therefore jobs.

“The supply normalization has already outpaced demand recovery,” said Yao Wei, China economist at Societe Generale SA. “In other words, the recovery so far is a deflationary recovery.”

Purchasing manager index figures for May underlined the slow nature of the recovery, with the manufacturing outlook slipping back.

Given the weak export outlook, manufacturers such as Fujian Strait Textile Technology Co. are switching their business models to target the home market. It used to sell 60% of its products to Europe and the US before the coronavirus crisis wiped out those sales. Now, Dong Liu, the company’s vice president, is looking for opportunities at home.

But the domestic strategy isn’t without its challenges. While China’s consumers are largely free to resume their regular lives as fresh virus cases slow to a trickle, they just aren’t spending like they used to.

Retail sales slid 7.5% in April, more than the projected 6% drop. Restaurant

and catering receipts slumped by 31.1% from a year earlier, after a 46.8% collapse in March.

Some producers may be hoping for a real-life enactment of Say’s law, a part of economic theory which suggests that ultimately supply will create its own demand, as long as prices and wages are flexible.

Another scenario is that industry self corrects, according to UBS Group AG’s Chief China Economist Wang Tao. She points to strong steel production during the depths of the coronavirus lockdown, even when demand was weak. Higher inventories means that even as demand recovers, steel production won’t show much of a pickup. And once producers know that orders are falling, they will adjust output.

“I do not think supply will outstrip demand for long — once inventories build up, or producers know orders are falling, production will come down as well,” she said.

That could pose other problems though, especially as unemployment rises. Premier Li Keqiang in a press conference on Thursday highlighted job creation as a critical priority for the government.

The urgency to create jobs may mean there’s even less likelihood of a shake-up of state owned companies in the heavy industrial sectors that have historically fueled excess production.

The disconnect is already clear in data points that show, for example, stronger coal consumption by power plants and rising blast furnace operating rates by steel mills, while at the same time gauges for property and car sales are improving more slowly. That combination will drag on China’s growth over the coming months, according to economists at Citigroup, Inc.

A scenario where manufacturers capacity originally dedicated to the export market is retooled to produce for the home market instead would still lead to overproduction. Then the supplydemand mismatch would end up adding to deflationary pressures and a pose fresh headwinds to economic growth, according to Bo Zhuang, chief China economist at research firm TS Lombard.

For now, China’s factory owners are hoping it won’t come to that. —