China’s bumpy reopening recovery
In recent commentaries we have highlighted the growing risk of recession in Europe and the US as we move in to 2023 (see our commentaries of November 2022 and July 2022). However, there is one major economy where prospects look set to improve through the course of next year: China. After a long period of sub-par performance, hopes have been raised for a “reopening recovery” in the world’s second largest economy as Beijing beats a retreat from its draconian zero-Covid policy, while also upping support for the troubled property sector, which has weighed heavily on growth in recent years.
In early December, Beijing announced that several key elements of its dynamic zero-Covid policy – which aims to suppress the virus and has been in place for nearly three years – would be relaxed. Mass testing has been abandoned and a negative test is no longer needed to access most public buildings and travel freely around the country. The much-feared policy of centralised quarantine, whereby those infected and those they had had close contact with were forced to isolate in state-run quarantine camps has also gone; those who are asymptomatic or have only mild symptoms can now isolate at home.
In addition, lockdowns, when they are deemed necessary, will be more targeted. Whereas previously an outbreak would have seen whole neighbourhoods or cities locked down, restrictions will now be focused on individual buildings or units. Also, lockdowns in designated ‘high-risk’ zones will be lifted after 5 days if no new cases are found.
The shift in policy followed widespread protests against covid restrictions in November.
However, rather than the protests per se, the realisation that the zero-covid policy was becoming untenable in the face of the more transmissible Omicron variant was probably a greater factor behind the change of stance. Faced with weakening external demand – the relaxation of measures came on the same day as data showing exports falling 8.7% y/y in November, the sharpest fall since February 20201 – the authorities will be aware that stronger domestic demand is needed to sustain growth and head off a further rise in unemployment, that could in turn result in more widespread social unrest.
There is little doubt that the zero-Covid policy has taken its toll on the economy. Air traffic has been around a third of pre-Covid levels2 and retail sales in October were down 0.5% from a year earlier3. Periodic lockdowns and their associated fallout have also dented production; Apple recently noted that a lockdown and ensuing protests at a key manufacturing hub in Zhengzhou led to a production shortfall of nearly 6 million iPhones4. One estimate suggests that Beijing’s zero-Covid policy has knocked around two percentage points off GDP growth in 2022 alone, which in absolute terms would equate to nearly US$400 billion in lost output5.
In light of these considerations, the relaxation of covid curbs and the associated increase in mobility should lead to an upswing in activity going forward. As has been seen in Western economies, the release of pent-up demand and the run-down of excess savings accumulated during lockdowns can provide a powerful boost to growth when economies open up. However, several factors complicate this narrative in China’s case.
Firstly, even though restrictions are being eased, Covid still carries the capacity to disrupt activity to a significant degree going forward. Due to low levels of natural immunity and domestic Chinese vaccines that are generally seen as less effective than their messenger RNA counterparts, Covid cases are expected to surge as the economy opens up (even though this is unlikely to show up in the official figures due to reduced testing). Reports indicate that hospitals are already becoming overwhelmed with Covid admissions in parts of the country, including Guangzhou6.
The combination of low levels of vaccination take-up amongst the elderly and lack of capacity in the healthcare system suggests there could be a vicious wave of deaths; some models suggest that an unchecked surge in cases could result in over a million fatalities within three months7. Given this prospect, even if renewed restrictions are not imposed to ease the strain on medical facilities, fear of the virus is likely to deter people from resuming life, and consumption patterns, as normal. In addition, on the supply side, production is likely to be impacted as a result of worker absences due to illness. These factors suggest that economic activity could experience a soft patch before picking up later in 2023 as herd immunity increases and fear ebbs away.
Reduced potential for a savings drawdown might also make the reopening consumption rebound less vigorous than that seen in the West. Goldman Sachs note that Chinese households have allocated more of their savings to less liquid financial assets, such as time deposits8. This could limit the degree to which Chinese households run down savings to fund a spending splurge as the economy opens up.
As well as the zero-Covid policy, the ongoing weakness of the Chinese property market has also weighed on consumer confidence. But here too there have been signs that the sector could become less of a drag on growth.
Regulatory guidelines designed to curb the debt of property developers introduced in the summer of 2020 have weighed on the sector over the last two years; property sales are down sharply and prices have fallen in annual terms for six consecutive months, dropping 1.6% y/y in October9.
However, a recent easing of policies towards the sector has encouraged expectations that the worst of the property downturn might be over. In November, the authorities introduced a series of measures to ease the financial strains on property developers and kickstart stalled construction projects, including a rolling back of restrictions on bank lending to the sector and supporting bond issuance for viable private businesses10.
With property and related industries accounting for up to 30% of Chinese GDP according to some estimates11, the combination of more supportive policies towards the sector and the easing of covid restrictions should improve the growth outlook through the course of 2023. Weekly data for early December has already shown signs of sequential improvement as reduced covid curbs allow potential homeowners to get out and view properties12.
This said, it is doubtful that a property boom capable of providing a powerful, sustained fillip to GDP growth is in the offing. Given President Xi’s view that ‘housing is for living in, not speculation’, the authorities are unlikely to facilitate a renewed run-up in speculative demand. Despite recent falls, high home prices are beyond the reach of many first-time buyers, and the parlous state of property developers has undermined confidence. The Chinese property industry also faces longer-term factors that are inhibiting demand, including an ageing population and a slowing pace of urbanisation.
Strained relations with the US, both over trade and the disputed territory of Taiwan, also cast a cloud over China’s reopening recovery. The Biden administration’s recent ban on exports of high-end semiconductors and high-tech equipment to China will stifle growth in the country’s tech sector and related industries. The prospect of a renewed flare-up in US-China trade tensions could also deter foreign direct investment into China at a time when companies are already reconsidering their supply chain dependence on the country following the disruption caused by the pandemic.
Against this backdrop, and with weak demand from Western consumers likely to weigh on Chinese exports, the recent lifting of restrictions which have held back domestic demand is perhaps unsurprising. Given policy easing regarding covid and the property sector, there are good reasons to expect a faster pace of GDP growth in 2023 following this year’s lacklustre expansion, estimated at 3.2% by the IMF13. Some China-watchers expect Beijing to announce a growth target of at least 5% for 202314. An ‘exit wave’ of covid cases suggests that the path to achieving such a pace is likely to be a bumpy one, and will probably require more growth-friendly policies from Beijing. Further out, structural headwinds (ageing population, slowing pace of urbanisation, property overhang etc.) suggest that China’s long-term potential growth rate is trending down. However, with recessions looming in both Europe and the US, China could be a relative economic bright spot in 2023.
12th December 2022