Why China will likely recover more slowly from the latest Covid shock

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As Shanghai attempts to reopen businesses, a downtown district over the weekend banned residents from leaving their apartment complexes again for mass virus testing. Pictured, in another neighborhood on May 21, 2022, is a line outside a shopping mall.

Xu Kaikia | Visual Group China | Getty Images

BEIJING — China’s economy will not recover quickly from the latest Covid outbreak, many economists predict.

Instead, they expect a slow recovery to come.

When the pandemic first hit in 2020, China rebounded from a contraction in the first quarter to grow in the second quarter. This year, the country faces a much more transmissible virus variant, weaker overall growth and fewer government stimulus measures.

The latest Covid outbreak that began in March has hit metropolis Shanghai the hardest. About a week ago, the city announced plans to come out of lockdown and fully reopen by mid-June.

“For China, the main story here is that we have seen the light at the end of the tunnel. The worst of China’s supply chain upheaval from the Covid lockdown appears to be over,” said Robin Xing, chief economist for China at Morgan Stanley, during a webinar on Friday.

“But we also think the road to recovery is likely to be slow and bumpy,” Xing said.

It’s a bumpy process. Over the weekend, a district in downtown Shanghai again banned residents from leaving their apartment complexes to conduct mass virus tests. More neighborhoods in the capital, Beijing, ordered people to work from home as the number of local daily cases rose – reaching 83 on Sunday, the highest for the city’s latest outbreak.

Case in point: German automaker Volkswagen, which has factories in two of the hardest-hit regions this year, said on Wednesday that its production sites in China were operational, but Covid controls were disrupting supply chains.

The automaker said it was unable to provide a specific figure on production levels because the plants are joint ventures operated with local partners.

Although the national number of Covid cases has fallen over the past month, pockets of new cases stretching from Beijing to southwest China have prompted stay-at-home orders and mass testing. Freight volumes remain below normal.

“Many regions and cities have tightened restrictions at the first sign of local cases,” Meng Lei, China equity strategist at UBS Securities, said in a note last week.

“Our case studies from Shanghai, Jilin, Xi’an and Beijing show that logistics and supply chain disruptions are the major pain points affecting the resumption of production,” Meng said. “Therefore, the return to work will likely be gradual rather than happening overnight.”

An “interrupted” policy-making cycle

The Chinese government has stuck to its strict “dynamic zero-Covid” policy despite the emergence this year of the highly transmissible variant of omicron.

“The most significant impact” of Covid’s resurgence is that it “interrupted” the normal policy-making schedule, said Dan Wang, Shanghai-based chief economist at Hang Seng Bank China.

She said the latest wave of cases and lockdowns only really started after the central government released its annual economic plan at the “Two Sessions” parliamentary meeting in March.

In China’s tightly managed economy, this annual meeting is an essential part of a national policy development and implementation cycle – across all counties and regions.

Supply chain disruptions and lackluster consumption are manageable, but once the political calendar is interrupted, “it’s difficult to get it back on its original course quickly,” Wang said.

There are so many different economic goals that “a lot of trade-offs have to be made between the different [government] departments,” she said. “It made the political process extremely slow and delayed.”

The Information Office of China’s State Council, the country’s top executive body, did not immediately respond to a CNBC request for comment.

Politics carries particular weight with officials this year ahead of a regular leadership reshuffle scheduled for the fall. Chinese President Xi Jinping is expected to stay on for an unprecedented third term.

Half the stimulus as in 2020

At the beginning of March, during the “two sessions”, Beijing set targets such as GDP growth “of around 5.5%”. But that’s about 1 percentage point or more above the forecasts of many investment banks – which have repeatedly slashed their China growth estimates as Covid lockdowns persist.

Wang maintains a relatively high forecast of 5.1% as she expects China to increase stimulus and ease strict Covid controls later in the summer.

But so far, nearly two months into Shanghai’s serious lockdown, policymakers have yet to make major changes.

Whether in terms of interest rates or fiscal policy, the level of government stimulus is still about half of what it was at the height of the pandemic in 2020, Morgan Stanley’s Xing said.

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With the exception of unemployment, most economic indicators have not reached worse levels than at the start of 2020.

Among other measures, the central government has announced tax and fee reductions for small businesses and has begun to cut mortgage rates. But the impact, especially on the massive real estate sector, may take time to be felt.

Xing noted that even without Covid, an easing of policies in the housing market would take three to six months to affect home buying activity.

Other parts of China are buzzing

Yet it is also possible that growth in China will be faster than expected.

“The silver lining is that the experiences of the past two years suggest that a Covid-induced recession tends to end quickly, especially with swift and powerful policy responses,” said Larry Hu, chief China economist at Macquarie, in a note last week.

For much of China, work continues, although there are additional virus testing requirements.

About 80% of manufacturing in southern China has returned to normal. Although the major city in the region, Shenzhen, closed almost all businesses for about a week in March, the transport of products by truck in a province is “OK” due to the very low number of Covid cases in the region, Klaus Zenkel, president of the southern China branch of the EU China Chamber of Commerce, told CNBC on Friday.

Members in the southern province of Guangdong — a manufacturing hub — “are all busy, they all have work to do,” Zenkel said. He noted that companies were keeping their warehouses fuller than before to avoid a prolonged shortage problem.

But “the unpredictability is there,” he said. “You don’t know what will happen.”

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