The preliminary reading of 49.6 for a Purchasing Managers' Index released Thursday by HSBC Holdings and Markit Economics compares with a final 50.4 for April and the 50.4 median estimate in a Bloomberg News survey. A reading above 50 indicates expansion. A separate Markit index for euro-area services and factory output increased more than forecast.
Asian stocks slumped after the data, which may test the new government's commitment to tolerate slower growth after Premier Li Keqiang last week signaled reluctance to add stimulus. Investors soured on China's outlook in a Bloomberg global poll this month, with the share of respondents who see the economy deteriorating doubling from January.
"The slowdown is really bad," said Ken Peng, a BNP Paribas economist based in Beijing. "It's a big probability now that China's GDP growth rate in the second quarter will be lower than in the first quarter," he said, referring to gross domestic product.
The MSCI Asia Pacific Index of stocks fell 3.2 percent as of 5:34 p.m. in Tokyo, headed for the biggest loss since November 2011, as Japan's Topix Index closed down 6.9 percent, the most since the aftermath of the Fukushima disaster in March 2011. The Australian dollar and copper also declined. The benchmark Shanghai Composite Index of stocks fell 1.2 percent at the close, the largest drop in a month.
A euro-area composite index based on a survey of purchasing managers in both services and manufacturing rose to 47.7 from 46.9 in April, London-based Markit said Thursday, adding to signs the currency union will emerge from its record-long recession in the second quarter. The result exceeded the median economist estimate of 47.2.
China's growth unexpectedly slowed to 7.7 percent in the first quarter while remaining above the government's full-year target of 7.5 percent. Data earlier this month on fixed-asset investment and factory production missed forecasts and gauges of manufacturing and service industries declined. The economy expanded 7.8 percent in 2012, the slowest pace in 13 years.
Second-quarter growth was projected at 7.8 percent, based on the median estimate in a Bloomberg News survey conducted from May 16 to May 21, down from last month's 8 percent forecast.
HSBC will release the final PMI reading on June 3. The National Bureau of Statistics and China Federation of Logistics and Purchasing will release their own PMI survey, with a bigger sample size, on June 1. The official PMI in April was 50.6, down from 50.9 in March.
The preliminary, or flash PMI is based on about 85 percent to 90 percent of responses from more than 420 manufacturers. Thursday's data reflect "slower domestic demand and ongoing external headwinds," Qu Hongbin, HSBC's Hong Kong-based chief China economist, said in a statement. Signs of labor-market slack "call for more policy support," Qu said. "Beijing still has fiscal ammunition to do so."
A gauge of output showed a preliminary reading of 51 for May, down from 51.1 in April, according to HSBC.
"We disagree with HSBC's call for firing fiscal bullets" because it's not in line with the new leadership's policy, said Steve Wang, chief China economist in Hong Kong for Reorient Financial Markets. Output is still expanding and an index of export orders improved, Wang said.
Previously released data showed industrial production rose 9.3 percent in April from a year earlier, below the median analyst estimate of 9.4 percent in a Bloomberg News survey. Fixed-asset investment excluding rural areas rose 20.6 percent in the first four months of the year, compared with forecasts for 21 percent.
The National Development and Reform Commission, China's top economic-planning agency, in April approved 54.6 billion yuan ($8.9 billion) of subway projects in four cities, according to statements posted on the commission's website.
UBS AG this week cut its economic-growth forecast to 7.7 percent from 8 percent for this year, joining Goldman Sachs, Royal Bank of Scotland and JPMorgan Chase & Co. in reducing estimates for 2013 expansion.
At the same time, economists have forecast that the People's Bank of China is more likely to raise interest rates than cut them in the coming year. Eight of 15 analysts surveyed by Bloomberg News earlier this month project an increase in the benchmark deposit rate by the end of June 2014, compared with two who see a reduction.
JPMorgan Chase & Co., among those projecting an interest- rate increase, said in a note Thursday that "there is no sign that the new government will introduce new pro-growth measures in the very near term despite the weak economic data."
Iron ore slumped into a bear market last week on concern that slowing economic growth in China, the world's biggest buyer, will hurt the outlook for demand. Prices will decline as supplies expand over the long term, Alan Chirgwin, general manager of iron ore marketing at Australia's BHP Billiton, the largest mining company, said May 8.