A key domestic manufacturing index dropped to a 32-month low in October, igniting market speculation that tight monetary policy may be eased.
The Purchasing Managers' Index (PMI) slipped to 50.4 last month from 51.2 in September, according to data released by the China Federation of Logistics and Purchasing (CFLP) on its website on Tuesday. The October figure was much lower than market expectations of 51.8. The index was 50.9 in August.
A figure above 50 indicates the manufacturing sector is expanding, while a figure below indicates a contraction.
The latest figure suggests that China's economic expansion could cool further in the fourth quarter, a statement from the CFLP said.
Most Chinese stocks fell on Tuesday amid market concern about an economic slowdown that may eat into corporate earnings despite speculation that the government could ease monetary policies to spur economic expansion.
The PMI is based on a survey of purchasing managers from 820 companies in 20 industries. Growth in the world's second-largest economy is likely to remain modest in the coming months but GDP for the entire year is predicted to increase by 9.2 percent, according to the CFLP.
China's economic growth rate was 9.4 percent in the first three quarters when measured against the previous year. In 2010, the year-on-year GDP increase was 10.4 percent, according to the National Bureau of Statistics.
Zhang Liqun, a senior researcher at the Development Research Center of the State Council, said that slower export growth and investment have dragged down economic expansion in the third quarter. The CFLP said that this is due to weaker
external demand amid eurozone debt problems while tight monetary policies have led to cash-flow problems for many companies.
The European debt crisis, for example, is still far from resolved, which may lead to a worsening situation in the fourth quarter, analysts said.
"Our leading index indicates that the European economy is set to continue slowing down and will enter recession territory in the fourth quarter," said Joseph Dong, president and chief economist of Peking First Advisory, in a research note. "China's economic slowdown may continue into next year."
European bankers are still suffering from limited access to funding. While eurozone leaders did reach an agreement on Oct 27 to rescue Greece by writing down 50 percent of its debt, a decision by Athens on Monday to hold a referendum on the aid package added to market uncertainty that the deal will go ahead.
"Further downside risks for China's exports may show up because we predicted that Europe - China's largest trade partner - is likely to fall into recession in the next six months," said Ma Jun, chief economist for Greater China at Deutsche Bank.
"As a result, export and investment growth is expected to continue to fall in the near future," Zhang said.
A PMI sub-index of new export orders dropped to 48.6 last month from 50.9 in September. On top of this, a sub-index for new orders declined to 50.5 year-on-year in October from 51.3 in September, the lowest for almost three years.
The sub-index of factory output also suffered a downturn last month, falling to 52.3 from September's 52.7.
If economic indicators continue to deteriorate the government may ease current monetary policy and give more priority to maintaining economic growth, Ma said.
A possible silver lining may be that input prices declined in October to 46.2, 10.4 points lower than September. It is the first reading below 50 in 32 months.
The drop suggests decreasing costs for manufacturers due to falling global commodity prices, Ma from Deutsche Bank, said. "This can also help to reduce inflationary pressure."
The Consumer Price Index, a main gauge of inflation, slipped to 6.1 percent in September from 6.2 in August and the more-than-three-year high of 6.5 percent in July.
Despite widespread concern about China's economic slowdown, Zhang Zhiwei, chief China economist at Nomura Securities, said that the low October PMI reading may be just seasonal and the economy still appears on track for a soft landing. The central bank, therefore, is unlikely to drastically change monetary policies in the last quarter of this year but it could take targeted measures to support sectors such as the construction of public housing and financing small-scale companies, he said.
HSBC on Tuesday released its China PMI for October. This figure is at 51 for October, up from 49.9 for September.
"Inflation is on track to ease, which provides leeway for Beijing to fine-tune policy to strike a better balance between growth and inflation priorities," said Qu Hongbin, HSBC chief economist in China.