Macro - China
Will a Chinese economic rebound help power global growth?
Henk Potts, London UK, Market Strategist EMEA
- After almost three years of strict COVID-19 restrictions, it’s expected that China’s rapid reopening of its economy will have a positive knock-on impact on global growth
- Following a sharp downturn in the property market in 2022, Chinese authorities plan to shore up its bruised property sector – as well as pledging enhanced support to the domestic economy – in further positive signs for growth
- Chinese inflation also continues to defy global trends – with inflation of just 2.5% expected this year – and this should help its central bank keep interest rates relatively low
- Despite escalating diplomatic tensions between China and the West, we’ve lifted our growth forecasts for China – reflecting the economic revival, stabilising housing market and anticipated policy support
As China’s economy reopens after a long period under a zero-COVID policy, early signs of a bounce in growth are encouraging.
For nearly three years, China enforced some of the strictest COVID-19 restrictions anywhere in the world. Its leadership had been unwavering in its commitment to the aggressive containment tactic, until a few months ago, despite most other countries accepting the virus as being endemic.
China’s rationale for sticking with the coronavirus suppression policy was based on lower efficacy rates for its domestically produced vaccine and poor vaccination rates amongst vulnerable groups, specifically the elderly. Authorities continued to proclaim that the restrictions were required to prevent the health service from being overwhelmed and to avoid a surge in death rates.
At the end of last year, however, the authorities abruptly abandoned their pledge to maintain the economically damaging zero-COVID strategy. Officials stopped the restrictive quarantine rules, finished mass testing and ended the practice of snap city-wide lockdowns.
After more than one thousand days, authorities have finally reopened China’s borders and international travel has resumed. The dramatic policy pivot should be positive for domestic activity, international supply chains and global growth prospects.
Fears over ending zero-COVID policy unfounded
The removal of the restrictions saw China suffer the world’s largest COVID wave, driven primarily by the highly transmissible Omicron variant. At the end of last year, daily infection rates surged into the tens of millions. However, official data suggest that hospitalisations have proved to be manageable and fears of millions of deaths have thankfully proved to be unfounded (albeit data transparency remains a source of debate).
We believe that the point of peak infections, following the Chinese New Year celebrations which always trigger huge amounts of people migration, has now passed and the population is approaching herd immunity status.
Reopening China’s economy
Historically, China’s growth has been driven by an expansion of credit and investment, although more recently, exports and property have become the main drivers. As we see the economy reopen from the depths of the pandemic, we would expect a broader-based recovery, with a strong emphasis on improving levels of domestic consumption.
The removal of travel and leisure restrictions has led to an unleashing of pent-up demand across the services sector. Recent mobility data have highlighted the sharp recovery in transportation usage and recreational visits. January’s services purchasing managers’ index (PMI) report demonstrated a strong rebound, with the index back above the expansion line, at 52.9 in January from 48 in December1. We forecast that services output will more than triple this year compared to 2022, with growth of 7%.
Retail sales are expected to recover and grow by 9-10%, following last year’s period of stagnation. In the medium term, more household debt and slowing real income growth among the middle classes could constrain demand. Balance sheets of wealthy households continue to look healthy, which should be positive for overseas spending as international travel resumes.
Beyond the reversal of COVID-19 restrictions, authorities are promoting growth by initiating a comprehensive plan to shore up the property market and pledging to offer a more supportive monetary and fiscal backdrop.
The Chinese housing market has slumped over the past year as developers defaulted on their debt, investment dried up and buyers boycotted mortgage payments.
Given the importance of the housing market to the economy (around one-quarter of gross domestic product), policymakers have instigated a broad range of measures to prop up the sector. The latest initiatives include credit support for housing developers, financial assistance to ensure the successful completion of projects and the loosening of restrictions on property purchases.
Whilst unlikely to be an instant panacea for the troubled sector, we think that the responses will start to stabilise the market. That said, property investment and homes sales are still likely to contract by around 5% this year.
Credit expansion and infrastructure investment should continue to support growth. The People’s Bank of China has urged banks to front load loans to the real economy. Credit growth should hold up, at around 9.5% in 2023 and infrastructure investment will probably remain robust with growth of around 6-8%. That said, manufacturing investment may moderate in coming quarters as spare capacity levels are elevated.
Inflation outlook crucial
Last year saw the People’s Bank of China cut policy rates, reduce the reserve requirement ratios, and relax credit criteria. The central bank has indicated that it will keep monetary policy relatively loose, in an effort to further aid the recovery, and expectations have been rising that further pro-growth policies will be announced at The National People’s Congress scheduled to take place in March.
The extent of future policy support will, in part, be determined by the inflation profile. China’s consumer price index (CPI) rose to 2.1% y/y in January compared to 1.8% y/y in December. The acceleration in inflationary pressures was driven by rising food prices and increased demand across the service sector as the economy reopened and consumers celebrated the Lunar New Year.
The recovery in demand and impact of low base levels from the second half of 2022 suggest that CPI will continue to rise through the year. We forecast that CPI will have risen to 3.2% in the final three months of 2022 and average 2.5% in 2023.
That said, we do not see the same acceleration in producer prices, given the slower manufacturing recovery and continued pressure on exports, meaning the producer price index could remain in deflation through the first half of this year.
Whilst we assume policymakers will remain accommodative, any signs that inflation is starting to move ahead of projections could create a more constrained fiscal backdrop.
Geopolitical tensions but hope for the global economy
China’s recovery path and its long-term plans to become a technology leader could be hit by escalating diplomatic tensions between China and the West. The US and China have clashed over trade tariffs, data transparency and in February over ‘spy’ balloons above America.
Meanwhile, the governments of Japan and Netherlands have reportedly agreed with the US to impose tough restrictions on the exports of advanced-semiconductor production equipment to Chinese companies. Despite the current hostilities, trade between the US and China accelerated to a total of $691 billion2 last year. However, a further souring of the relationship between the two superpowers could impact growth prospects.
Considering the rapid reopening of the economy, the stabilising housing market and ongoing policy support, we have upgraded our GDP growth forecast for this year to 5.3%. Leaving aside the geopolitical tensions that exist, long term, China should transition to become a more sustainable, high-tech, domestically focused economy which would be positive for its people and investors in the region.