The most immediate threat to China's economy isn't external. It's internal.

China's economic challenges include weak consumer sentiment and demand. Costfoto/NurPhoto/Getty Images

• China's economy faces immediate internal challenges, with weak demand dragging on production.
• Two recent gauges of China's manufacturing activity point to strong export demand amid weak domestic sentiment.
• China's property crisis and weak consumer confidence drag on manufacturing activity.

China's economy is under siege from tariff hikes by the US and the European Union, both of which are major trading partners — but this may not be its most immediate threat.

Instead, China's sluggish internal domestic demand appears to be a more pressing issue.

In June, China's official Purchasing Managers' Index — which represents larger companies and state-owned enterprises — contracted for the second straight month.

In contrast, an S&P Global PMI reading — which reflects activity at export-oriented small and medium private businesses — showed output growth hit a three-year high in June.

That means consumer demand within China is slowing, even as demand for made-in-China products grows externally.

The divergence is important because China — the world's factory floor — could face lower global demand for some of its exports after trade tariffs kick in.

In a recent report, economists at Nomura wrote that there are "concerns that China's economy will be unable to sustain a strong recovery through depending only on exports."

The market's conviction in China's recovery is eroding, the Nomura economists wrote, with China's benchmark CSI 300 index giving up some gains after hitting a May peak.

While exports may continue to support growth in the coming months, "it probably won't overcome weakness on the domestic side," Eric Zhu, an economist at Bloomberg Economics, said on Monday.

China's unwilling consumers are dragging on factory activity

China's PMI readings underscore the challenges in the country's economy.

China is currently trying to weather a painful economic transition, which is contributing to an uneven economic landscape.

It's also facing an epic real-estate crisis, stock-market volatility, geopolitical headwinds, and demographic challenges.

The economic uncertainty is contributing to weak consumer sentiment and risk hedging. People are spending their money on gold and experiences instead of discretionary goods.

Weak consumer demand is bad for China's economy, as it can contribute to a vicious cycle of deflationary pressure on the back of slowing wage growth and consumer spending.

"The divergence between expansionary production and contractionary new orders suggests activity data on the supply side may continue to outperform demand-side activity data, which is likely to exert continued downward pressure on goods prices," the Nomura economists wrote in a separate note on Monday.

The contraction in official manufacturing PMI and a pullback in industrial profits also validate concerns of "'too little, too late' policy stimulus," Vishnu Varathan, the chief economist of Asia excluding Japan at Mizuho Bank, wrote on Monday.

"Doubts that Beijing has a handle on economic revival are justifiably mounting," Varathan added.

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