(Reuters) - China's factory activity sputtered in December, underlining the challenges facing the country's manufacturers as they fight rising costs and softening demand in a cooling economy.

After a rough 2014, the world's second-largest economy looks set to start the new year on a weak note, reinforcing expectations that Beijing will roll out more stimulus to avert a sharper slowdown which may trigger job losses and debt defaults.

A property slump is expected to last well into 2015, companies will continue to struggle to pay off debt and export demand may remain erratic, leaving only the services sector as the lone bright spot in the economy.

China's official Purchasing Managers' Index (PMI) slipped to 50.1 in December from November's 50.3, a government study showed on Thursday, clinging just above the 50-point level that separates growth from contraction on a monthly basis.

Analysts polled by Reuters had forecast a reading of 50.1.

"This indicates that industrial growth is still in a downward trend, but the pace (of declines) is slowing," Zhang Liqun, an economist at the Development Research Centre, said in a statement accompanying the report.

"The current economic situation is in the process of returning to stability from slowing down," Zhang said.

A similar private survey on Wednesday showed activity shrank for the first time in seven months in December. That survey focuses on smaller companies, which are facing greater strains, notably higher financing costs and problems getting loans.

The official survey looks more at larger, state-owned firms, which have been more resilient to the protracted downturn, partly due to generous government subsidies and better access to credit.

Many analysts expect economic growth in the fourth quarter to slow only marginally from 7.3 percent in the third quarter, though a raft of weak data suggest that may be too optimistic.

That means full-year growth will undershoot the government's 7.5 percent target and mark the weakest expansion in 24 years.

Economists who advise the government have recommended that China lower its growth target to around 7 percent in 2015.


In a bid to spur growth and keep borrowing costs down, the central bank unexpectedly cut interest rates for the first time in more than two years on Nov. 21. It has also injected more funds into the banking system in recent months and relaxed restrictions to persuade risk-averse banks to lend more.

In addition, the economic planning agency has been approving more infrastructure projects.

While its recent moves may have bought the central bank some time to see if conditions improve, many economists still expect more interest rate cuts as well as reductions in banks' required reserve ratios (RRR) this year, perhaps as soon as the first quarter.

That would allow banks to lend more money at more attractive rates, but authorities will still need to find a way to stimulate genuine demand at a time when many businesses are pulling back.


Some hopeful signs have emerged from recent data, though analysts say they may only partly offset the downdraft from the weak property market and its knock-on effect on other industries, which is weighing on demand for everything from furniture and glass to cement to steel.

Growth in China's services sector, which accounts for close to half of the economy, remains robust, though firms are still shedding jobs. The official non-manufacturing Purchasing Managers' Index, or PMI, rose to 54.1 in December from November's 53.9.

Authorities want services to overtake manufacturing as the bigger driver of activity in coming years.

Export demand may also be bottoming out, with a stronger U.S. economy helping to offset weakness in Europe and Japan.

An index for new orders - a proxy for foreign and domestic demand - retreated to 50.4 in December from November's 50.9. But new export orders shrank at a slower rate, climbing to 49.1 in December from 48.4 in November.

The private HSBC/Markit activity survey showed new export orders increased.

The official PMI also indicated big Chinese factories were weathering the downturn better than their smaller counterparts, as banks prefer to lend to state-owned firms, assuming the government will bail them out to prevent any defaults.

The PMI for large manufactures was 54.6 last month, while business shrank for small-to medium-sized factories.