Asia Weakness Heightens Fears of Contagion

By MICHAEL S. ARNOLD And TOM ORLIK

The latest Chinese manufacturing numbers are sounding alarm bells that the Western economic turmoil could begin to drag down regional economies. The WSJ's Jake Lee talks to Aaron Back about how China can keep from being affected.

Manufacturing activity in China and across a wide swath of Asia slowed in May, heightening fears that the turmoil in Western economies is dragging down one of the few remaining engines of global growth.

Two purchasing managers indexes for China fell in May, briefly rattling investors Friday and stoking talk Beijing may have to respond aggressively to support growth. Indonesia posted its first trade deficit in nearly two years, and South Korea's exports, considered a bellwether for Asia, unexpectedly fell for a third straight month.

"The green shoots of recovery that we were seeing a month or so back are wilting away," said Rob Subbaraman, chief Asia economist at Nomura Securities. "The crisis in Europe is one reason; the other one is the China slowdown. But I think less appreciated is that the height of uncertainty about the outlook has caused Asian firms and multinationals in Asia to pause in their investments, and I think that's the bigger factor right now."

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China's official PMI, based on government data, showed manufacturing continuing to grow but by the barest of margins, falling to 50.4 in May from 53.3 in April. A figure above 50 indicates expansion. Meanwhile, an index produced by HSBC and Markit slipped to 48.4 from 49.3, pointed to worsening conditions for small private firms and exporters.

The new evidence of continued deceleration in China's economy has raised concerns among some economists that Beijing's stimulus efforts may be too limited and too slow to prevent a further slump.

"We feel that in China a very powerful stimulus"—combining fiscal outlays and cuts to banks' reserve-requirement ratio—"is required to arrest the slowdown in growth," said Frederic Neumann, co-head of Asian economic research for HSBC. "These numbers today suggest this is coming sooner rather than later. If that stimulus is not delivered, then China is indeed looking at a hard landing."

The data come as Europe's spiraling debt crisis and the sluggish U.S. recovery are washing up on Asian shores in the form of weaker demand for exports and capital flight from risk.

Most of Asia's stock markets, which began the day weaker on global concerns about Europe, slipped further on the weak data.

Asian currencies also extended their declines, with traders saying Bank Indonesia again intervened to defend the rupiah.

The stark exception in Asia, the yen, has served as a haven for risk-averse investors, boosting the Japanese currency to three-month highs against the dollar and undermining vital exporters.

China's dour manufacturing readings were mirrored across the Asian-Pacific region. A PMI for Australia fell deep into contractionary territory, down 1.5 points in May to 42.4, while HSBC's inaugural PMI for Indonesia fell to 48.1 in May from 50.5.

Indexes in South Korea and Taiwan both showed growth slowing but remained barely positive, with South Korea's HSBC PMI falling to 51.0 from 51.9 and Taiwan's to 50.5 from 51.2. India's PMI held up better, ticking down to 54.8 from 54.9.

The slowdown in China doesn't appear to have spread fully to other Asian countries—yet. Partly, HSBC's Mr. Neumann said, it's because other Asian countries didn't tighten policy last year as sharply as China, which feared overheating and runaway inflation. But there also may simply be a time lag.

"Everybody had always looked to China as the pillar of Asian growth, but it turns out that in the current environment these smaller economies are actually holding up better," he said. But, "if China continues to slow, ultimately the weakness will spread to the rest of Asia."Across the world, there was also gloom. Brazil's manufacturing sector showed contraction for a second straight month, though the reading was unchanged. The euro zone posted its own manufacturing drop and its deepening fiscal crisis continued to take its toll on some of its neighbors. In Turkey, the May PMI fell to 50.2 compared with 52.3 in April.

Write to Michael S. Arnold at michael.arnold@dowjones.com and Tom Orlik at Thomas.orlik@wsj.com

A version of this article appeared June 2, 2012, on page A7 in the U.S. edition of The Wall Street Journal, with the headline: Asia Weakness Heightens Fears Of Contagion.