^{Photo: South China Morning Post}

China’s Factory Activity Suffers Biggest Decline Since 2022, as Global Trade Headwinds Deepen

China’s manufacturing sector took a sharper-than-expected hit in May, raising fresh concerns about the health of its economy amid mounting global trade tensions and weakening domestic demand. According to the Caixin/S&P Global manufacturing PMI, factory activity fell to 48.3, well below the neutral 50-point mark that separates growth from contraction. This marks the steepest monthly decline since September 2022 and is significantly lower than April’s reading of 50.4 and economists’ expectations of 50.6, based on a Reuters poll.

Sharp Drop in Export Orders Underscores Trade Challenges

A key driver of the contraction was a sharp decline in new export orders, which fell to their lowest level since July 2023, signaling weakening demand from overseas buyers. The Caixin report highlighted that overall new orders also shrank for the first time in eight months, painting a grim picture for both external and domestic demand.

The ongoing trade war with the U.S. is a central factor. Although U.S. President Donald Trump recently paused 145% tariffs on Chinese goods for 90 days after a diplomatic meeting in Switzerland, existing tariffs continue to weigh heavily on Chinese manufacturers. According to the Peterson Institute for International Economics, average U.S. tariffs on Chinese goods still stand at 51.1%, while China's tariffs on U.S. goods are at 32.6%.

Weak Job Market and Rising Inventories Add to Pressure

Employment in the manufacturing sector also took a hit, shrinking for the second consecutive month and at the fastest pace since January 2024. This reflects factories’ cautious outlook as they scale back hiring amid falling orders and lower capacity utilization.

Adding to the sector’s woes, finished goods inventories rose for the first time in four months, largely due to delayed outbound shipments and falling sales. This indicates that manufacturers are producing more than they can sell — a red flag for future output.

“Uncertainty in the external trade environment has increased, adding to domestic economic headwinds,” said Wang Zhe, Senior Economist at Caixin Insight Group. “Major macroeconomic indicators showed a marked weakening at the start of the second quarter.”

Divergence Between Official and Private Data

The Caixin data, based on a survey of over 500 export-oriented smaller firms, contrasts with the official PMI released by China’s National Bureau of Statistics (NBS), which surveys 3,000 larger, mostly state-owned companies. The official PMI rose slightly to 49.5 in May from 49.0 in April but still remained in contraction for the second straight month.

Economists at Goldman Sachs noted that the timing of the surveys may explain part of the discrepancy. The Caixin survey is conducted mid-month, potentially missing late-May developments such as tariff pauses or stimulus effects, while the NBS data reflects full-month activity.

Non-Manufacturing Sectors Show Mixed Signs

The official non-manufacturing PMI, which includes construction and services, edged down slightly to 50.3 from 50.4, remaining above the expansion threshold for 17 consecutive months. The Caixin services PMI for May is expected to be released on Thursday, and will provide further insight into consumer-facing sectors.

Exports Rise, But Not Enough to Offset Broader Weakness

Despite the manufacturing downturn, China’s exports grew 8.1% year-on-year in April, outperforming expectations thanks to increased shipments to Southeast Asia. However, exports to the U.S. and Europe continue to fall amid tariff pressures and slower consumer spending in Western markets.

Meanwhile, industrial output rose by 6.1% in April, down from 7.7% in March, suggesting that production growth is losing momentum. Industrial profits rose for a second consecutive month, thanks to targeted government stimulus efforts such as liquidity support and interest rate cuts.

Policymakers Turn to Stimulus to Cushion the Blow

In response to the economic softening, the People’s Bank of China cut key policy rates by 10 basis points and slashed the reserve requirement ratio (RRR) by 50 basis points in May, injecting more liquidity into the financial system. These measures aim to support small- and medium-sized enterprises (SMEs), many of which are struggling to access affordable credit.

Beijing is also trying to stimulate consumer spending through targeted subsidies and pension reforms, though results so far remain tepid. Retail sales rose only 5.1% year-on-year in April, missing forecasts and signaling caution among consumers. Wholesale prices fell at the fastest pace in six months, continuing a two-year deflationary streak, and consumer prices fell for the third straight month.

Real Estate and Investment Continue to Drag Down Growth

Investment in China’s crucial real estate sector fell 10.3% year-on-year from January to April, deepening the country’s property market slump. This slump, combined with weak exports, has eroded two of China’s main growth engines.

“As what used to be the top growth drivers — property and exports — become growth drags, Beijing might finally be forced to support consumption in a much more sustainable way,” said Ting Lu, Chief China Economist at Nomura. “This could mean pension reforms or offering birth subsidies to stimulate spending and improve long-term demographics.”

Final Thoughts: More Action Needed

The disappointing May PMI data underscores the urgency for more aggressive and coordinated policy action from Beijing. While recent steps by the central bank are welcome, they may not be enough to offset a simultaneous slump in global trade and domestic investment.

China's economy is at a critical juncture. To reignite growth and restore confidence, policymakers may have to shift focus from export- and construction-driven growth to domestic consumption, innovation, and structural reforms — all of which require time, political will, and public trust.