China post-COVID: from zero to hero?

Following China’s abandonment of its Zero-COVID policy in early November, the resulting wave of daily COVID cases likely peaked around year-end or in early January.

This is what our simulation below shows and what the reopening experiences of Hong Kong and Taiwan suggest. Online searches for ‘COVID’ or ‘fever’ have also peaked, which in other countries heralded an improvement in the COVID situation.

Daily activity data provides further evidence that the worst of the outbreak is probably behind us.

Car and subway traffic is rebounding in big cities, inter-regional freight traffic is picking up and property sales are on the rise again. This is not confined to large urban areas. Phone surveys by independent research provider Dragonomics suggest that 80% of the rural population has already caught the virus – even before travel surrounding Chinese New Year started on January 9 – and that activity is beginning to normalise.

This healthy rebound in activity suggests we got the big picture right and that our bullish 5.2% growth forecast for 2023 needs no revision. However, the full reopening happened earlier than we expected and so the bulk of the rebound has been shifted from the second to the first half of this year. While other investors have largely caught up with our bullish outlook, we remain on the bullish side of forecasts.

What kind of rebound should we expect?

We believe the key driver of this recovery will be consumption, in particular in contact-intensive consumer services, alongside the property sector. Not only does reopening allow potential customers to view homes again, but policymakers have finally taken the necessary steps to restore confidence in the sector. Meanwhile, the tentative loosening of the government’s aggressive regulation of the tech sector should act as a tailwind.

Exports should slow in 2023, given weaknesses in Europe and the US, but a significant slowdown had already taken place, given rolling COVID outbreaks in China and the easing of bottlenecks in the rest of the world.

Unlike in the West, we don’t expect China’s reopening to be accompanied by runaway inflation. Fiscal stimulus was much smaller in China than in the US and Europe when including transfers to households. In addition, China’s economy displays greater slack after three years of lockdown and having not implemented furlough schemes. That is not to say that inflation won’t rise, but we expect it to remain below the 3% inflation target.

China’s current account should deteriorate as external demand slows and domestic demand improves, including for foreign travel. The renminbi, though, is driven by capital flows and the economic cycle; we expect it to appreciate further.

China’s rebound is unique in that it will not be driven by policy support. With leverage having reached record highs across the economy, the leadership is likely to scale back infrastructure investment. For the same reason, the government has made clear that credit would grow in line with nominal GDP, implying broadly constant credit growth from here.

Global implications

The recovery in China should be less commodity intensive than in past upwswings, given that it is driven by consumption versus stimulus and investment. Admittedly, construction should pick up in 2023, but this would be tempered by a dial-down in infrastructure investment. Also, China’s recovery is taking place against a slowdown in the US and Europe – a further dampener.

By extension, China’s recovery should not fuel global inflation. Apart from the commodity channel, we don’t expect major supply disruptions. China has been expert at managing supply chains at the height of outbreaks, so we see little reason to worry now that the virus wave has peaked. Bottlenecks at the global level have also disappeared, opening alternative sources of supply.

Positive spillovers from China’s rebound should also be somewhat smaller than in the past. This is because consumption recoveries are less import-intensive than investment recoveries.

However, China’s recovery will be felt, particularly in its Asian neighbourhood. The main beneficiaries are likely to be Taiwan, Malaysia and Korea via trade in goods, as well as Thailand and Vietnam via tourism.

Latin America, on the other hand, is likely to benefit less than it has in the past through the commodity channel and may be more aligned with the US cycle due to proximity.