China’s factory sector recorded its third consecutive month of contraction in June, underscoring the mounting challenges posed by persistent deflation and sluggish domestic demand. The official Manufacturing Purchasing Managers’ Index (PMI) edged up to 49.7 from May’s 49.5 but remained below the 50‑point threshold that separates expansion from contraction. With producer prices plunging and consumer prices stagnating, the world’s second‑largest economy faces renewed urgency to invigorate industrial activity even as policymakers roll out targeted stimulus measures.

Deflationary Pressures Weigh on Factories

Despite a modest uptick in production and a slight improvement in new domestic orders, Chinese manufacturers continue to struggle under the weight of deepening price declines. Factory gate prices, measured by the Producer Price Index (PPI), fell by 2.7 percent year‑on‑year in May—marking the most severe drop since mid‑2023—and have now registered over two years of cumulative deflation. This collapse in producer prices squeezes profit margins, prompting many firms to curb output or delay capital investment.

On the consumer side, the Consumer Price Index (CPI) has languished in negative territory for four straight months, with a year‑on‑year decline of 0.1 percent in May. When households expect prices to keep falling, they tend to defer purchases, further weakening demand for manufactured goods ranging from electronics to autos. In June, the PMI’s sub‑indices for inventories and employment dipped to 48.0 and 47.9, respectively, signaling that factories are trimming stocks and cutting back on hiring to cope with weak orders and shrinking revenues. Meanwhile, export orders remain in contraction—albeit slightly less so—reflecting both lingering tariff frictions and subdued global demand.

Policy Measures Offer Limited Relief

In response to the manufacturing malaise, Beijing has rolled out a mix of monetary and fiscal measures aimed at stabilizing activity and reversing deflationary trends. The People’s Bank of China (PBOC) has pledged to accelerate targeted easing, cutting benchmark lending rates in May and injecting liquidity through medium‑term lending facilities. Reserve requirement ratios for major banks have been nudged lower to free up funds for small and medium‑sized enterprises, many of which account for a substantial share of factory output and employment.

On the fiscal front, authorities have mobilized additional resources for infrastructure spending under the NextGenerationEU‑inspired recovery plan, earmarking tens of billions of dollars for high‑speed rail, renewable energy projects, and digital‑economy pilot zones. Local governments have been encouraged to step up bond issuance—both on‑budget and off‑balance‑sheet—so as to sustain construction activity and buoy non‑manufacturing sectors such as logistics and services. Last week, Premier Li Qiang reaffirmed plans to turn China into a “consumption powerhouse,” announcing consumer vouchers for durable goods, expanded trade‑in programs for vehicles and appliances, and pilot subsidies for e‑commerce purchases in rural areas.

Yet despite these efforts, the impact on factory output has been uneven. While large state‑owned enterprises with deeper pockets have tapped cheaper credit to maintain production, smaller private factories face tighter financing conditions and rising real debt burdens as deflation erodes their revenue base. The non‑manufacturing PMI, by contrast, rose slightly to 50.5 in June—driven largely by an uptick in construction activity—highlighting the growing divergence between China’s infrastructure‑led recovery and its struggling industrial core.

Outlook Hinges on Demand Rebalancing and Structural Reforms

Looking ahead, analysts warn that patchwork stimulus alone may prove insufficient to lift the manufacturing sector out of its slump. With China’s traditional export markets grappling with slowing growth and trade tensions still unresolved—even after a tentative trade truce earlier this summer—external demand is unlikely to provide a lasting upturn. At the same time, the property sector, once a pillar of domestic investment, remains a drag as local governments work through excess housing stock and financial strains in shadow‑banking channels.

Policymakers are therefore emphasizing a shift toward a consumer‑driven growth model, investing in social welfare programs, urbanization initiatives and digital infrastructure to create new sources of demand for manufactured goods. The “Made in China 2025” strategy—originally launched to upgrade the nation’s industrial capabilities—has been reinvigorated with fresh targets for advanced manufacturing sectors such as electric vehicles, robotics and semiconductors. By fostering innovation clusters and easing market access for private investors, Beijing aims to move factories up the value chain, where price competition is less acute and profit margins can be more resilient.

International financial institutions have revised down China’s GDP growth forecasts for 2025—from around 5 percent at the start of the year to closer to 4 percent—citing deflation’s drag on consumption and investment. As the government approaches key leadership meetings later this year, pressure will mount to deliver more comprehensive structural reforms: streamlining administrative approvals, liberalizing interest rates, and bolstering household incomes through tax cuts or social transfers. Any misstep could deepen deflationary expectations and prolong the manufacturing downturn, with ripple effects across global supply chains.

China’s manufacturing contraction in June underscores the delicate balance policymakers must strike: deploying enough stimulus to revive factories and stave off deflation, while avoiding excessive debt accumulation and financial risks. Success in this endeavor will hinge not only on the scale of fiscal and monetary interventions but on the government’s ability to foster sustainable demand—both at home and abroad—and to shepherd Chinese industry into higher‑value, innovation‑led sectors that can thrive even as global competition intensifies.

(Adapted from CNBC.com)