As zero-Covid ends abruptly, China’s economy is living its darkest hours before the dawn

[walterbibikow]

●What was assumed to be a gradual reopening has turned into a sprint to the exit. This means deeper near-term disruptions but the rebound is also likely to be more vigorous

China has entered 2023 with trepidation. While the abrupt end to the zero-Covid strategy has boosted market confidence in better economic conditions ahead, it has also cost society, with the public health system under significant pressure amid surging infections. With the situation still very fluid, any forecasts need to be constantly revisited as conditions evolve.
The situation is murky from a public health standpoint. The halting of daily data updates on Covid-19 cases and deaths has left the market flying blind on where the nation is along the infection cycle. Indeed, with mass testing no longer being carried out and a self-reporting system yet to be established, it is challenging even for the government to gauge the true picture.
The former chief epidemiologist of the National Health Commission, Zeng Guang, estimated that over 80 per cent of residents in Beijing (a city of 22 million) had contracted the virus by the end of last month, and that over 40 per cent of China’s entire population (roughly 600 million) might have been infected.

The economy is living its darkest hours before the dawn. November’s activity data nosedived, and December purchasing managers’ indices (PPIs) show a continued contraction. When the fourth quarter gross domestic product data comes in, it is expected to show a dreadful end for the economy in 2022.

But financial markets seem undeterred by China’s economic and societal struggles. Instead, confidence has been buoyed by its reopening and signs of the economy bottoming out in regions that appear to have passed peak infection. The MSCI China index and Hang Seng index are up over 30 per cent since the policy pivot, and the exchange rate is below 7 yuan to the dollar again.
Looking ahead, the Covid-19 policy shift requires a re-examination of China’s economic outlook. Compared to the three-stage reopening envisaged previously – which assumed Beijing would shore up its medical defences before reopening domestically and then relaxing border controls – stage 1 has been skipped entirely and stages 2 and 3 are near completion. What was assumed to be a six-to-nine-month gradual reopening has turned into a two-month sprint to the exit.

This means deeper near-term disruptions – which the economy is experiencing – but also what is likely to be a more vigorous growth rebound. The balance of risks to the market’s 2023 growth forecast has shifted to the upside.

The revival of Chinese demand will create some price pressure but, from a domestic inflation perspective, the starting point is important to consider. Three years of sub-trend growth has left the economy with a large output gap, manifested in multi-year-high unemployment rates and persistent disinflation.
Consumer price inflation was only 1.6 per cent in November, with core prices barely growing, while the PPI has contracted since last October. It is likely to take a strong and enduring recovery in domestic demand to absorb these excess capacities before inflation can rise sustainably from the nadir.

From a monetary policy standpoint, the People’s Bank of China has been more conservative than its developed-market counterparts in stimulating the economy. Growth in M2, the broad money supply, is less than half of the peak reached in the United States, and the cuts to the reserve requirement ratio for banks and interest rates have been underwhelming, relative to market expectations.
Globally, supply chain bottlenecks have largely disappeared and commodity prices are no longer surging. Barring another major geopolitical conflict, energy and food prices should be better behaved in 2023.

Some worry that the rebound in Chinese demand will fuel another commodity price upcycle. But if the market is right that the coming recovery will be driven more by consumption and services, the impact on global commodity prices should be more limited.
Looking past the overhanging cloud, an important medium-term question is whether the pandemic has permanently scarred the Chinese economy. Some signs of long-term damage are evident in anecdotal reports of foreign businesses shifting supply chains out of China, and mass closures of small and medium-sized enterprises. These mean that some of the increase in youth and migrant-worker unemployment may be difficult to reverse going forward.
Analysing the impact of these developments will take time. But if the growth trend has indeed been lowered by the pandemic, China will either struggle to restore growth to pre-Covid-19 levels, or if it tries aggressive stimulus, inflation could rise as lower supply capacity fails to keep up with demand. Clues on these could come to light as the recovery takes hold in the coming months.

Opinion | China’s economy is living its darkest hours before the dawn

What was assumed to be a gradual reopening has turned into a sprint to the exit. This means deeper near-term disruptions but the rebound is also likely to be more vigorous.

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