Operating conditions in China's manufacturing sector declined in January, for the sixth consecutive month, according to the latest purchasing managers' index (PMI) published by CLSA Asia-Pacific Markets, This shouldn't come as much of a surprise given the global economic slowdown. What's worrying is that layoffs are on the rise, which could cause economic and political stability problems for China.

"Levels of new business fell for the sixth consecutive month in January," says CLSA in its latest PMI report. "Moreover, despite easing for a second month running, the rate of contraction remained considerable, reflecting rapidly deteriorating market conditions and fears of a deepening economic downturn."

The PMI produced for brokerage CLSA is based on a survey of more than 400 manufacturers across China, and is believed by many observers to provide a snapshot of the health of the overall economy. It judges activity in the manufacturing sector by deriving a score from a range of indices that measure the change in output, new orders, employment, suppliers' delivery time, and the stock of purchased goods. The further the final score is from 50 means a faster change in the sector's level of activity. The latest score was 42.2, far below 50, the level at which there is no change. This is slightly higher than the scores for November and December, 40.9 and 41.2 respectively, but it is still the third worst score in the survey's history.

Perhaps the most worrying result in the latest report is the level of manufacturing layoffs, which is also at its highest peak since the survey began. Employment levels in factories continue to drop as employers keep staff numbers lean to stave off the problems of tight operating margins. There are fears that a rise in unemployment could make for a dissatisfied population which could cause social instability. This is not only a problem relating to out-of-work factory workers, but also the six million new graduates who will flood the job market this year.

In a note released yesterday, J.P. Morgan's head of China equities, Jing Ulrich, pointed out that high levels of unemployment have hit China before without shaking the society's foundations. In the six-year period when the state-owned enterprises were restructured, between 1997 and 2003, 40 million people lost their jobs. There were also losses resulting from China's accession to the World Trade Organisation. "During this period, social discontent increased without impacting overall stability," says Ulrich.

Of course, during that time when the state-owned sector cut back, there was a burgeoning private sector that could pick up some of the unemployed. Many of those losing their jobs now are migrant workers who will have to go back to the farm. There is a chance, says Ulrich, that some of these workers will be able to pick up construction jobs created by the massive stimulus programme. But if they don't find jobs, there's a chance that this time around, the social instability could be far more significant, which is what makes reports like this CLSA research key indicators.