Waiting for China

Waiting for China

China's slowdown dashes hopes for a quick regional recovery, and the longer its Covid lockdowns last, the bigger the impact will be.

Since China began to open up and reform its economy in 1978, growth has averaged almost 10% a year, and more than 800 million people have been lifted out of poverty. There have also been significant improvements in access to health, education and other services, with the mainland now an upper-middle-income country.

But rapid development based on resource-intensive manufacturing, exports and low-paid labour has largely reached its limits and has led to economic, social and environmental imbalances. China is also a major influence on other developing economies through trade and investment, and its economy is an important source of global demand.

Economic expansion has now moderated in the face of structural constraints, including declining labour force growth, diminishing returns on investment and slowing productivity. Following real gross domestic product (GDP) growth of 8.1% in 2021, expansion of 5% or even lower is projected this year.

The forecast reflects rising headwinds as domestic demand has slowed, while the global economic environment has worsened significantly with the war in Ukraine. In addition, China is currently experiencing the largest Covid-19 wave since the end of the first national lockdown in March 2020.

Key economic figures tumbled in April as virus lockdowns, including in the financial capital Shanghai, choked business activity and unstable global commodity markets raised fears about growth. Retail sales fell 11.1% year-on-year, deteriorating further from a 3.5% contraction in March, with demand for food and vehicles among the hardest hit, the National Bureau of Statistics reported.

The mainland's international trade has slowed to levels not seen since the height of the pandemic nearly two years ago. The value of exports and imports in dollar terms rose just 2.1% year-on-year last month, the weakest since June 2020.

Economists have expressed fears that the slowdown in China could drag down an entire region trying to sustain a fragile rebound amid easing Covid restrictions in several countries.

"A protracted slowdown in the PRC is a significant risk, as it would negatively affect Asia's economic outlook," Matteo Lanzafame, senior economist at the Asian Development Bank (ADB), told Asia Focus.

Amid Covid outbreaks and mobility restrictions, leading economic indicators suggest manufacturing and services activity is at its lowest since early 2020.

For instance, the non-manufacturing purchasing managers' index (PMI), which includes services and construction, dropped to 41.9 in April -- well below the 50-point threshold that separates expansion from contraction. The manufacturing PMI, meanwhile, dipped to 47.4.

Data on port activity and construction paints a particularly gloomy picture. At this stage, the ADB expects lacklustre growth in the first half of the year, followed by a substantial pickup later if Covid-related restrictions are eased.

"But there remains a risk that supply disruptions and softer economic activity could last longer -- and so would the negative spillovers to other economies in the region, which is your next question," Mr Lanzafame pointed out.

Hunter Chan, Greater China economist at UK-based Standard Chartered, expects trade to fall further in light of soft demand and logistics disruptions, as strict testing requirements for drivers and multiple checkpoints stretch delivery times.

Industrial production in April fell 2.9% year-on-year, the biggest decline since February 2020, reflecting material and labour shortages. Automobile sales sank 31.6% from a year earlier.

Fixed asset investment slowed slightly in April, and while growth in the first four months of the year was 6.8% from a year earlier, that was down from a 9.3% pace in the first three months. Resilient infrastructure investment -- benefiting from policy support -- was expected to partly offset the drag from falling real estate investment and weaker manufacturing investment, Mr Chan noted in a paper published before the figures were released last week.

Mr Lanzafame believes the China slowdown may affect regional and global economies through at least two channels: demand from Beijing for their exports and supply chain disruptions.

"A protracted deceleration of industrial activity in the PRC would be particularly damaging for import demand from several Asian economies, which export intermediate goods and other inputs for industrial use," he said.

Meanwhile, global supply chains are still under significant stress, he noted. "A prolonged crisis in the PRC would further damage the ability of firms, both in the region and elsewhere, to source necessary production inputs."

One possible upside is that a protracted slowdown in China could result in lower global demand for commodities. This would help alleviate price pressures on energy and other commodity markets, which remain elevated in the wake of Russia's invasion of Ukraine, he said.

Several investment banks have already cut their China growth forecasts since last month, and Mr Lanzafame said the ADB might follow suit. Its Asian Development Outlook update in April projected the Chinese economy would expand by 5% this year, a considerably more optimistic figure than the latest one from Nomura, which forecasts 3.9% growth, down from 4.3% previously.

The International Monetary Fund (IMF) last month lowered its China GDP forecast for the second time this year. The new projection is for 4.4% growth, down from 4.8% forecast in January, which in turn was a reduction from 5.6% predicted in October last year.

Although the Chinese government is expected ease some policies to shore up growth, Mr Lanzafame noted that "the key challenge is really to get mobility restrictions lifted or substantially reduced", he said.

"A protracted deceleration of industrial activity in [China] would be particularly damaging for import demand from several Asian economies," says Matteo Lanzafame, senior economist with the Asian Development Bank. Supplied/ADB


All eyes were on Shanghai last week, after it declared on Tuesday that it had achieved "zero-Covid" status across all its districts. Mayor Zong Ming has set out plans for the return of more normal life from June 1, ending a gruelling lockdown that has lasted more than six weeks.

According to official figures, more than 3.8 million people officially were still under the strictest forms of lockdown in the city of 25 million.

The Covid caseload nationwide is easing, though the threat of lockdowns remains as more infections are found in key cities and the country continues to have zero tolerance for any outbreaks.

Cases crept up last week in Beijing, with 64 local infections through Thursday afternoon, compared with 49 on Wednesday. The capital locked down some areas of the Fengtai district for seven days and began three rounds of mass testing across four districts.

In nearby Tianjin, where an Omicron outbreak in January disrupted auto production by Toyota and Volkswagen, the port city's 13.7 million residents were asked to "remain at a relative standstill" over the weekend for more mass testing.

The Word Health Organization (WHO) has warned that with more transmissible Omicron variants spreading, China's approach is no longer "sustainable".

"The virus is evolving, changing its behaviour," said Dr Tedros Adhanom Ghebreyesus, the WHO director-general. "With that … changing your measures will be very important."

Although Omicron is more contagious, it comes with a lower risk of hospitalisation compared with the Delta variant.

Prof Fan Gang, executive director of China's National Economic Research Institute, has defended the zero-Covid strategy. However, he believes the government is cautiously rethinking the policy.

"The zero-tolerance policy in the past two years basically meant zero deaths. Basically, since the Wuhan lockdown, China has had no deaths," he said. (The country had recorded 5,218 deaths as of last Thursday, but almost all of them occurred in the first two months of the pandemic.)

"But now if you open up, if you change the policy, the death rate could still be very much lower than before but that toll could be unimaginable with a 1.4 billion population," Prof Fan told a recent virtual forum hosted by the Singapore Institute of International Affairs (SIIA).

"That's why I think policymakers are very cautious," he noted. "I believe they are thinking [about changes] because now you see from social media that there are lots of comments and suggestions. Of course, people are still cooperative but it is different from the time of the Wuhan lockdown.

"During that time, people understood that it was a serious illness so they were very cautious. But when people know that Omicron has very light symptoms and without a high death rate, people are starting to think differently."

As the government considers a policy change, Prof Fan said authorities are speeding up vaccinations in rural areas and for the elderly. "They have also started to build more modular hospitals, even in Tibet, to prepare for the worst case. The situation is still very uncertain."

Nonetheless, he admitted that the zero-Covid strategy has affected the Chinese economy severely. "In March, consumption actually had minus growth. The second-quarter figure could be very low, I would say."

The impact on the service sector, production and transport is also growing. "Now it has very negative impacts on exports. That means negative impacts on the global supply chain. That is the largest factor that determines how the macroeconomy will perform this year," he said.

Speaking at the same event, Prof Bert Hofman, director of the East Asian Institute at the National University of Singapore, said Chinese authorities had wasted a lot of time by sticking to the zero-Covid policy.

"Vaccination rates are way too low," he said. "The switch will happen but it will take at least a couple of months to catch up on the vaccination rate.

"In between, the policies are [being followed] in the extreme because they come from the top and everybody wants to show that they follow the policy. Actually, the lockdown could be much more relaxed with almost the same results."

Given a two-week lockdown requirement, Prof Hofman said people don't want to travel or go out even if they are allowed to.

Workers in the service sector, many of them migrants from rural areas, are insufficiently covered by social safety nets and can't afford the risk of moving about.

"Retail sales are now in negative territory. Consumption overall has not been very good because the employment situation is not very good due to the lockdown," he said.

"Nobody goes to restaurants. Even if you are not actually locked down, you don't go to a restaurant because if there is only one case found in that restaurant, you might be locked up under the zero-Covid policy, So, there is a lot of hesitancy."

"Frankly, I think there are more reforms going on than many people think … that in the end will deliver on the productivity increase that China is looking for," says Prof Bert Hofman, director of the East Asian Institute at the National University of Singapore. SUPPLIED


Prof Hofman said positive economic data seen in China early this year was largely a spillover from 2021. "Last year wasn't great because the fiscal engine started to work very late and therefore you see a very positive outcome from infrastructure investments in the first quarter.

"Manufacturing investment was really good in the first two months. It's now really starting to taper off."

Thankfully, massive investments have been made in the energy sector as Beijing steps up its energy transition drive. Between now and 2060, between 2.5% and 3% of annual GDP will be spent on renewable energy, transmission and related projects.

"That is actually the new engine. It's no longer the roads, the bridges and the railways. Now it's the new energies that could be the big engine of infrastructure investment," said Prof Hofman.

"It is essential that the switch is made," he said, adding that the emphasis would be on "more sensible investment" as opposed to high investment volume.

China, he said, will have to grow on the consumption side. "There's a lot of opportunities there and once they do, I actually see a relatively benign growth outlook."

More investment is also needed in education "as education levels in China's working population are still very low". As well, the retirement age should be revised up as the labour force is shrinking.

"If the retirement age is pushed up to a sensible number, say 65, you will find an additional level in the labour force of about 40-45 million people," he said.

"There are a lot of sources of growth on the supply side that can make a lot of potential growth out there in an optimistic scenario, with lots of productivity increase."

China has embarked on several reforms, particularly last year, in sectors like tech, e-commerce, housing and education, but Prof Hofman stressed that all kinds of changes are needed to make the economy more efficient.

"Frankly, I think there are more reforms going on than many people think, believe and say. I actually believe there's quite a bit of reform dynamics in China that in the end will deliver on the productivity increase that China is looking for."

Prof Hofman expressed concern that if a more statist approach is used, and state enterprises are allowed to dominate even more than in the past, then China could face far lower productivity growth.

But he ruled out the possibility that China will experience negative growth even if the country is thrown into a debt crisis, something many experts fear. "You still have a very big chunk of investment that will continue to drive growth, though it will be far less efficient growth."

The debt crisis, if it happens, will cost China one or two years of growth, he said. "But it won't make your growth disappear. You may lose some level but then you'd continue to grow again. That's the experience of other countries.

"I'm sure China can manage that. They might lose a year or two years of growth with a debt problem but they won't lose growth momentum," he added.

Even if easing lockdowns results in fewer deaths than before because Omicron is relatively mild, "that toll could be unimaginable with a 1.4 billion population", says Prof Fan Gang of the National Economic Research Institute of China. SUPPLIED

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