Employees work at a manufacturing plant of Sany Heavy Industry Co. during a government-organised tour of manufacturers based in Changsha, Hunan province, China, October 19, 2019. REUTERS/Thomas Peter

By Joe Cash

BEIJING (Reuters) -China's industrial profits grew at their fastest pace in nearly two years in September, marking a second straight month of gains and signalling long-awaited measures designed to curb overcapacity and rebalance the economy may be gaining traction.

Top leaders in July vowed to take steps to tackle loss-making, inefficient firms, prompted by rising fears of entrenched deflation in the world's second-largest economy driven by brutal price wars and weak domestic demand.

Analysts said Beijing's policy shift, which occurred as U.S. tariffs weighed on exports, amounted to reversing years of using cheap loans to prop up jobs and sustain provincial economies.

Giving policymakers cause for optimism, industrial profits rose at an annual rate of 21.6% in September - the fastest pace since November 2023 - following a 20.4% jump in August, data from the National Bureau of Statistics showed on Monday. Industrial profits grew 3.2% over the January-September period.

The figures cover firms with annual revenue of at least 20 million yuan ($2.81 million) from their main operations.

SUPPLY AND DEMAND MORE BALANCED

"The overall supply-demand picture has become slightly more balanced, industrial capacity utilisation has improved and industrial enterprise profit margins have increased," said Xu Tianchen, senior economist at the Economist Intelligence Unit.

"The producer price index also rebounded slightly, a small positive step in the long journey to rebalancing the economy."

That said, China's $19 trillion economy remains far from stable, weighed down by a prolonged property slump, a fragile job market and heavily indebted local governments.

Gross domestic product grew 4.8% in July-September, slowing from 5.2% in the second quarter, officials announced last week, keeping pressure on policymakers to roll out more stimulus to shore up momentum.

And while the growth rate kept China on track to reach its target of roughly 5% this year, the economy's dependence on external demand at a time of mounting trade tensions with Washington raises questions over whether that pace can be sustained, as does its reliance on large, state-owned firms.

Private-sector firms' profits rose 5.1% in the first nine months of the year, though analysts noted the figure was skewed by a handful of large companies, including Chinese electric vehicle battery giant CATL, whose net profit jumped 41.2% year-on-year.

State-owned firms posted a 0.3% decline in profits over the same period, the data showed. Many are highly exposed to recent global commodity price spikes and cannot easily lay off staff to improve margins, economists said.

GROWTH AIDED BY A LOW BASE EFFECT

NBS statistician Yu Weining said the high-tech and equipment manufacturing sectors had boosted the headline year-to-date figure, with growth also supported by a low base effect.

"We expect industrial profit growth to decline in October as favorable base effects fade away," Nomura economists said in a note to clients.

Chinese consumers have continued to shy away from discretionary spending. Top private traditional Chinese medicine maker Zhangzhou Pientzehuang Pharmaceutical reported a 28.8% drop in third-quarter net profit, marking its second consecutive quarterly decline.

The country's leadership last week reaffirmed efforts to rebalance the economy toward domestic demand in the government’s new five-year plan. But it still appears to view its vast manufacturing sector as central to sustaining growth, despite a growing number of trade partners threatening tariffs in frustration over the economy's structural imbalances.

"Sectors with a high exposure to the U.S. market continued to be hit by the tariff impact," said Lynn Song, chief economist for Greater China at ING.

($1 = 7.1230 Chinese yuan)

(Additional reporting by Qiaoyi Li; Editing by Jamie Freed)