China’s Campaign to Wipe Out Covid Is Crushing Its Economy

Date: Monday, May 2, 2022
Source: Bloomberg

Virus outbreaks and a property slump are forcing Xi Jinping to put his revamp of China’s economy on hold—and he faces mounting pressure to reverse last year’s policies.

The omicron variant of the coronavirus slipped through China’s border controls and is causing the largest outbreaks since Wuhan in 2020. About a quarter of China’s population lives in cities that are now under some form of lockdown. Most of Shanghai’s 25 million residents have been confined to their homes for more than a month. High-frequency indicators, such as city-to-city truck flows, suggest China’s economy is contracting, and residents in multiple cities are struggling to find food and even dying from lack of medicines.

The economic outlook ranges from bad to very bad. In the most optimistic scenarios, the pace of new outbreaks slows as cities institute early and short lockdowns. In worse-case scenarios, China could face multiple Shanghais each month over the second and third quarters, which would raise the risk of a recession—something the country hasn’t seen in the modern era.

With roadblocks across the country to prevent the spread of infections, activity at Chinese ports has plummeted, further straining global supply chains. Chinese financial and currency markets have sold off, and demand for imports of oil and other commodities is plunging.

The human suffering is raising doubts about the Chinese Communist Party’s governing capacity. “There are a lot of unsatisfying decisions from the party,” says Ada Yuan, a finance worker in Shanghai. “This is a big lesson for all of us after the country enjoyed a safe, stable environment without Covid-19.”

It’s a contrast from the initial phase of the pandemic—when China’s successful “Covid Zero” strategy, combining strict border controls, mass testing, and quarantine of anyone infected—made it the only major economy to avoid a deep contraction. Foreign investment flowed in, and Xi and the rest of the CCP’s elite Politburo announced that the rapid rebound had opened a “strategic window” to reshape the world’s second-largest economy.

China Annual GDP, Year-over-year Change

Source: National Bureau of Statistics of China

In a flurry of regulatory moves, Beijing reduced the power of China’s largest internet companies, wiped out the for-profit tutoring industry, and took on video streaming sites and delivery platforms. Then came an ambitious campaign to slow debt growth, especially in the real estate sector, which accounts for about 20% of China’s economy. The moves sent a clear signal that the party’s vision of “common prosperity”—greater equality, national security, financial stability, and technological self-sufficiency—would take precedence over the demands of big business and wealthy investors.

Growth itself was downgraded: Xi wrote his name into a landmark party resolution in November, declaring that gross domestic product was no longer the “sole yardstick” of development.

Strains from this approach became clear less than two months later, when a massive real estate slump sucked oxygen from the economy. Xi and the Politburo declared that the top task was now economic “stabilization,” and credit growth began to accelerate. Cities started to ease housing restrictions.

China’s National People’s Congress, which meets in full session for roughly a week each March, went even further. Not content with stabilizing the economy, it set an aggressive GDP growth target of “about 5.5%” for 2022. Common prosperity got a single mention in the Government Work Report, a policy document that outlines a vast range of economic and development tasks for the country to pursue over the coming year.

China's Forecast Year-Over-Year GDP Change

Economists forecast China growth below target for the first time since 2014

Sources: Bloomberg surveys, China National People’s Congress

Note: No official target was given in 2020. If official target is a range, lower end of the range is used in the calculation.

Political considerations most likely prompted the turnaround. At a once-every-five-years party conclave this coming fall, Xi is expected to secure a third term as party leader, in defiance of recent precedent. That means economic growth and job creation—the traditional means of ensuring social stability—are back at the top of the agenda, and dozens of senior officials across China also vying for promotion at the congress will be graded on how they deliver on these metrics.

“Beijing seems to have realized that it went too far on many things, including on tech platforms and property, and are now making course corrections,” says Tianlei Huang, an economist at the Peterson Institute for International Economics. “Economic policy is indeed more improvised this year.”

While the ink on the work report was drying, the highly infectious omicron variant was silently creeping into dozens of Chinese cities. It had already torn through Hong Kong in February, killing thousands. But China’s leadership was distracted by Vladimir Putin’s invasion of Ukraine: Unprecedentedly tough sanctions on Russia, combined with Beijing’s close ties with Moscow, had foreign money managers asking if China was becoming “uninvestable.” Hong Kong-listed Chinese stocks registered their sharpest drop since the 2008 financial crisis.

Economy czar Liu He called China’s top financial regulators in for an early morning meeting on March 16. In an about-face from the previous year, he declared they should “actively implement policies that benefit markets.”

In the tech hub of Shenzhen, officials ordered a lockdown after daily cases ticked up into the dozens, and the outbreak was suppressed in a week. In Shanghai, a financial center and China’s largest metropolis, officials initially played down the likelihood of a lockdown. So when they later declared one, many residents were caught without stockpiles of food and medicine. As in Hong Kong, lack of planning and poor execution created man-made disasters. Reports of an elderly person who died of asthma after ambulances refused to take him to a hospital attracted more than 55 million readers.

As activity in locked-down cities ground to an almost complete halt, the government directed aid at businesses, not households. Workers in the informal economy, deprived of income, subsisted on handouts from local volunteers.

Xi stayed aloof from the disaster in Shanghai, avoiding the city while reaffirming the government’s commitment to Covid Zero. Speaking at a celebration honoring Olympic athletes held in Beijing in early April, he said, “Some foreign athletes told us that if there was a gold medal for epidemic response, it should be awarded to China.”

Although the botched Shanghai lockdown has dented confidence in the Covid Zero approach, Xi and the rest of China’s top leadership are not under threat. Local communist cadres get very little guidance on how to execute on the targets and policies the government hands down, and they shoulder much of the blame when things go wrong.

Make no mistake: Judged purely on public health grounds, China’s Covid Zero strategy has been a demonstrable success so far. Not only has it sharply curbed deaths compared with Western nations, but it also has allowed the country to concentrate its more limited health resources on an extensive vaccination campaign. Eighty-eight percent of the population has received at least two shots, one of the highest proportions anywhere. And half have gotten boosters, compared with about 30% in the U.S.

Nevertheless, the risks of quickly exiting Covid Zero should not be understated. A wave of infections would trigger a spike in worker absenteeism and overwhelm China’s hospital system, partly due to a lower vaccination rate among elderly people.

Zhong Nanshan, the Chinese doctor who is the country’s equivalent of Anthony Fauci, wrote in March that elimination policy “cannot be pursued in the long run.” But he said a shift would require improved vaccination coverage, including the deployment of mRNA shots not yet available in China in combination with vaccines already on the market, and reliance on antibody rather than PCR tests.

A more immediate problem for the government is shoring up an economy that’s decelerating rapidly. China has signaled that it will allow local governments to load up on off-balance sheet debt to finance the core of its stimulus plan, a list of major investment projects worth at least $2.3 trillion this year. “The markets are preparing for more stimulus and possibly a flip-flopping on real estate,” says Jeremy Stevens, chief China economist at South Africa’s Standard Bank.

Many economists say they fear that the renewed focus on top-line growth will come at the expense of efforts to make China’s economy more sustainable. “The 5.5% target is too aggressive,” says Chen Zhiwu, a professor at Hong Kong University who’s advised China’s securities regulator. “Given the upcoming 20th party congress, they may still try all these measures to achieve it, even at the cost of further messing up the economic structure.”

Yuen Yuen Ang, an expert on Chinese policy at the University of Michigan, predicts Xi will revert to his common prosperity agenda, which seeks to purge the excesses of China’s Gilded Age, once he secures a third term. “The mission is not going away,” she says. The risk for Chinese households and investors both here and abroad is that the current pause will necessitate even more draconian measures to set China back on the course Xi has charted. —Tom Hancock, with Allen Wan


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