Barclays with a good note that sums up my own views nicely. I’d only add that whatever the final growth figure this year it will be grossly exaggerated.
Downside risk increasing
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How has China credit performed so far in the recent local COVID outbreak? China credit spreads started to widen on 6 April, when Shanghai extended its lockdown to the entire city.
Concerns intensified this week as cases spread into Beijing, where several districts immediately began locking down. China IG, HY non property, and HY property spreads widened by 11bp, 37bp and 700bp respectively since 6 April (Figure 2). Among HG sectors, SOEs, Financials and LGFVs were relatively resilient, with spreads little changed. (Figure 7).
How did China credit perform in the previous local COVID outbreaks?
We find that before the recent Shanghai lockdown, China spreads had been resilient to domestic COVID lockdowns. The only notable selloff was in January-Febrary 2020, at the very beginning of the pandemic. Even then, the selling appeared relatively contained and short-lived (IG 10bp, HY non property 49bp, HY property 121bp), and had stabilized within about two weeks. It was followed by the much-larger selloff that accompanied the outbreak going global in March 2020. (Figure 1)
China credit was able to weather later rounds of local COVID outbreaks (Figure 3). We think this possibly reflects market expectations that the virus could be effectively contained in a relatively short time frame, meaning business interruption from zero-COVID policies was shortterm/minimal. (We think the weakness in January 2022 was mainly driven by non-COVID considerations, including developments in the China property sector, and broader market sentiment.)
Why this time could be different?
Given the Omicron variant’s high level of transmissibility and apparent ability to outpace containment efforts, we think downside risks have clearly increased.
• In early 2020, Wuhan, the epicenter of the first wave of the COVID, was locked down for ~2.5 months (late January to April 2020). However, the outbreak in the rest of the country was mostly brought under control within a few weeks, business activity (outside consumer facing services) rebounded rapidly and had been operating more or less as normal ever since. Credit spreads also stabilized.
• Shanghai in 2022 launched a phased lockdown to curb the Omicron outbreak on 28 March. But as cases continued to surge, the city extended the lockdown to the entire city on 6 April. China’s biggest city is now enduring its fourth week of full lockdown, but daily new COVID cases in Shanghai remained at 10k+ lately. Outside of Shanghai, more cities have reported local cases, including big cities like Beijing and Hangzhou. Notably, a number of highways
across the country were closed as governments took measures to contain the spread of the virus. The disruptions were visible in indexes tracking e-commerce logistics and express deliveries, which have seen sharp declines during the recent outbreak – something that did not happen during other outbreaks over the past two years – as local governments restrict traffic within and between provinces/cities. (Figure 5 and Figure 6).
Could it be worse than Jan-Feb 2020, or March wides in 2022?
We think Omicron brings more uncertainty. Figure 4 and Figure 9 show that the frequency and the scale of local outbreaks has increased since the emergence of the Delta variant in May 2021, and has further picked up since Omicron. Therefore, even if the outbreaks in Shanghai and Beijing can be contained in the next few weeks, we would expect more disruptions as a result of targeted lockdowns/restrictive measures as long as dynamic-zero-COVID policies remain in place. We note that China’s leadership and institutions have stated their willingness and intention to minimize the economic impact of such measures. 3
However, Shanghai’s experience may serve as a lesson for local officials in other parts of the country to use increasingly harsh measures to control local cases. Cities such as Xuzhou in eastern China and Shanghai’s neighbour Suzhou have redoubled their COVID control/preventive measures amid the dismissal of several local officials, apparently for not being swift enough to respond to outbreaks.
In addition, the macro backdrop in 2022 is different to early 2020, in an unfavorable way. Globally, rising risks to growth, geopolitical frictions, and a more aggressively hawkish Fed are among the main concerns. And within China, weakness in the property sector and concerns about evolving regulatory scrutiny remain.
In the meantime, policy makers appear to have more limited options, given a number of macro considerations such as inflation and capital outflows5 compared with 2020, when global central banks were easing and willing to take coordinated action in face of a global health emergency.
Shanghai and Shenzhen set two lockdown templates
1) Type 1: Shenzhen model – quick in and quick out. The city in March managed to get ahead of the infection curve after lockdown for a week and reopen relatively smoothly. 6
2) Type 2: Shanghai/Jilin model. In the event the virus not contained in short order, then prolonged lockdowns may ensue. Based on the cases of Shanghai/Jilin, lockdowns could extend beyond a month.
In our view, “Quick in, quick out” mode is likely to be adopted more by local governments, to avoid Shanghai style lockdown and misery. (Zhong Nanshan , China’s top respiratory expert who once headed China’s COVID response team, also mentioned that a big lesson from Shanghai’s COVID outbreak is that “quick in, quick out” appears to be the better way to contain Omicron7). Guangzhou’s swift response is a recent case where local outbreak was brought under control within a few days.
The evolving Beijing COVID situation is the next test case to see if local governments are able to clean up cases in the community in big cities effectively and efficiently.
Credit implications from Lockdowns/restrictive measures
We think the impacts on credit could mainly come from:
• Weak sentiment on concerns about China growth.
• Impact on corporate fundamentals from: a) Demand side – weak consumption/activity due to lockdowns and other restrictive COVID measures; b) Supply side – Business disruptions caused by the lockdowns.
The length and scale of the local outbreak and the duration and severity of restrictive measures are key determinants of the impact on corporate fundamentals. Geographic and business
diversification may help mitigate the damage. Below we look at how offshore bond issuers operating in different sectors may be affected by measures to try and halt the spread of COVID in China. Our main observations are:
• “Lockdown credits” – Consumer and transport sectors: could be more affected, hurt by likely restrictive lockdown measures, including transportation suspensions, travel bans and reduced customer traffic. This trend is also visible in the headline PMIs –the manufacturing PMI appears relatively resilient while the services PMI is more volatile and more sensitive to COVID. (Figure 10 and Figure 31)
• Industrials or resources companies likely to be less directly affected: Data shows these sectors have remained relatively resilient, given their less-populated geographic location, and government efforts to prioritize the factory productions to balance the economic impact.
• HY more vulnerable, and HG corporates could be more resilient given their stronger credit fundamentals, such as higher cash balances. (Figure 7 and Figure 12)
• “Non-lockdown” credits are unlikely to be immune. Weak sentiment and concern about growth could also weigh on the non lockdown credits. In the recent local outbreaks, non lockdown credits have been performing resilient so far – Segment spread didn’t really see weakness so far, while spread widened for close to 15bp in early 2020. (Figure 11).
Omicron battle bites; a heavy disruption scenario could lead to sub-4% growth China has been facing widespread and persistent Omicron waves since March. With Shanghai (China’s biggest city) now in a fifth week of stringent lockdown, Beijing announced a partial lockdown of Chaoyang district (home to ~3.5mn people) on Monday and said aimed to conduct three rounds of city-wide nucleic acid testing for ~20mn population in the following five days.
Beijing’s performance will be crucial to watch in terms of how long the zero-COVID policy may last (see China: Zero-COVID – calibrations and implications, 28 April 2022). Overall, the MarchApril activity data released so far show a significant COVID-lockdown hit to consumption and services, while the impact on manufacturing was relatively contained.
In China: GDP downgrade on Omicron, 18 Apr 2022, we cut our 2022 GDP growth forecast to 4.3% factoring in a 150bp drag in Q2 growth from the Omicron battle. This assumed 1) the lockdown in Shanghai would be lifted by end-April, and 2) COVID outbreaks in the rest of China would be broadly brought under control by end-May. If Beijing outbreaks could be brought under control in two weeks, this would already be captured by our current base case forecasts.
However, the latest developments suggests, 1) in Shanghai, the lockdown is likely to extend into May, at least partially, with daily COVID cases staying above 10k, and 2) elsewhere in China, the repeated, widespread (partial) lockdown could become a norm in H2 as omicron has been proved to be more transmissible and difficult to contain.
We maintain our below-consensus GDP growth forecast though acknowledge that repeated and/or prolonged multi-city lockdowns suggest further downside risks.
We explore a heavy disruption scenario, taking into account a) more widespread outbreaks, b) longer (partial) lockdowns, extending into June and H2, and c) more severe output loss during lockdown periods. In the heavy disruption scenario, where we see much deeper cuts to the rest of year, with an additional 50-100bp cuts in Q2 (with drag from Shanghai accounting for half of downside risks), and 100-200bp cuts in H2 (assuming similar magnitude of impact to areas outside of Shanghai in Q2 to be extended to H2).
If this scenario were to unfold, this would imply the 2022 annual growth forecast falling into a range between 3-4% versus our base case forecast of 4.3% and the official growth target of ~5.5%.