Omicron remains the single most-important China macro variable. We think healthcare and political constraints mean the zero Covid policy is here to stay for at least the next six to nine months. Beijing is pushing on the stimulus accelerator, but the Covid brake on activity will remain and pulldown full year growth to 3.3% yoy with risks to the downside. Second-and third-order impact of zero Covid make stabilizing property prices and providing stimulus more difficult. There are, however, two reasons for faint optimism: newly released directives on Covid control that seek to mitigate economic spillovers from city-level lockdowns and corruption investigations into testing companies and local officials. The former indicates that the worst in Covid-related economic damage may be over, but it does not alter our view that rolling lockdowns will persist over the next six to nine months. This points to more fiscal and monetary easing, with an extra government bond quota highly likely. Overall, the outlook reinforces our negative RMB view and is supportive of infrastructure-related equities and China bond steepener trades.
Zero Covid is here to stay. We have long maintained that China’s zero Covid policy will persist throughout 2022, as healthcare (ICU beds, vaccination rates) and political considerations (the upcoming Party Congress) prevent a relaxation in policy. The over-80s are particularly vulnerable, with a national vaccination rate estimated at 20% and little sign of increased vaccine uptake in the past weeks. Meanwhile, state media and politicians continue to emphasize the need for “faster, stricter and more effective prevention and control measures.”
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A Covid exit strategy is likely six to nine months in the making. China is clearly thinking about exiting “zero Covid”, but changes are unlikely before the 20th Party Congress in Q4/22. Our understanding based on statements from China CDC officials is that the thresholds to exit include an 80% vaccination rate for the over-80s, expansion of ICU capacity and reducing fear of the virus (pressure on WHO to downgrade Covid-19 severity could come into play).
Faint signs of change. Eight days ago, the State Council announced the “nine ‘do nots’”, providing national guidance to limit the economic and supply chain hit of the zero Covid policy. At the same time, a number of corruption investigations into testing companies and local officials received greater prominence in domestic media. The outcome of the investigations and their portrayal in state media will offer a gauge of the central leadership’s commitment to strict zero Covid. The next signpost on the way to a Covid exit is a stronger 80+ vaccination push. National guidelines on pre-vaccine screening and existing medical conditions would be a positive signal of increased urgency (prospective jab receivers and vaccine centre staff are often reluctant to risk complications). The model is shifting slightly; but within the hard zero Covid framework, the bias is still towards lockdowns, broader changes are likely only after the Party Congress.
China is recovering slowly from the Shanghai lockdown and widespread supply-chain disruption. Future outbreaks are likely to be less economically disruptive than that seen in AprilMay, as policymakers tweak their response to the more infectious variant. However, the recovery will be slow. Two years ago, China bounced back from the initial outbreak thanks to very strong external demand, a property boom and a relatively less infectious Covid strain. In 2022, diametrically opposite conditions apply.
More stimulus is needed. Tax and fee cuts equal to US$ 1.5 trn have come through but are designed to stabilize rather than generate growth. It is infrastructure that will be the main demand driver in 2022. An RMB3.65trn special-purpose bond quota, ~RMB2trn in unspent infrastructure funds from 2021, and a 16% increase in central government transfers would, in normal times, constitute a substantial infrastructure spending war chest. However, owing to testing requirements for workers, general mobility restrictions and their large second order impacts, and the cost of maintaining the Covid test and trace apparatus (around 2% of 2021 GDP with 1.6 mn people employed for this purpose) coming out of local government budgets, infrastructure spending will be less effective than it has been in the past. China’s broad fiscal multiplier is estimated at between 0.8-1.4, infrastructure spending multiplier is higher at roughly 2 (decreasing in the past five years), with a 1 percentage point increase in infrastructure FAI growth adding 0.12 percentage points to GDP growth. Given Covid constraints, we think the multiplier this year is likely closer to 1. For infrastructure to stabilize growth, Beijing will need to provide more funding. We have noted strong indications of an extra bond quota since April, and expect RMB1-2trn in special Covid bonds issuance in H2/22 – enough to push full-year infrastructure FAI into high single digits.
Monetary easing is even less effective. Credit demand – particularly from households – remains very weak. Falling property prices and wages, combined with faltering consumer confidence, mean that mortgage lending, which typically accounts for one-third of new loans, was at 10 year lows in April and May (Chart 2). At the same time, private businesses are reluctant to borrow. Credit data for May illustrates the problem: although aggregates bounced back sharply from April lows, the recovery was led by government bond issuance and short-term borrowing. Businesses, with good credit lines, happily pocketed cheap loans forced out by the PBoC, likely buying money market funds to undertake interest-rate arbitrage. Medium- to long-term loans, usually used for capex, grew by less than short term lending for only the second time in the past six years. China will need to continue easing monetary policy to support growth: we expect a 50bps RRR cut (or equivalent) and 10bps of policy rate cuts in H2, in addition to strong window guidance to banks.
Slow growth and continued monetary and fiscal easing have clear market implications. We are long USD/CNY in Macro Strategy and expect growth and rate differentials to push RMB to 7.2 against the dollar in the next six months (see here for full details). China yield curves are likely to steepen as high bond issuance prevents the long end falling even with strong monetary support, while PBoC easing lowers the front end. Finally, we prefer infrastructure-related equities and are moving to neutral on China equities in our EM Asset Allocation.
Despite improvements in local Covid case numbers and tweaks within the zero Covid framework, China remains stuck. Beijing is pushing the stimulus accelerator but slamming on the zero Covid brake. We think growth is what will give and forecast China TSL GDP at 3.3% yoy in 2022 with risks to the downside. More stimulus is needed – and is coming – but Beijing will fall well short of its official growth target this year.
Spot on. Here’s the latest on COVID from Sinocism:
1. Beijing’s outbreak from Heaven Supermarket Bar
Beijing is now back on the precipice of broader lockdowns as a superspreader event at a sketchy Sanlitun bar (tautological?) has led to hundreds of cases across the city. The sword of dynamic zero-Covid can fall at anytime.
Authorities have refrained from restoring the toughest of the earlier restrictions, but about 10,000 close contacts of the customers of the bar have been identified and their residential buildings put under lockdown.
Chaoyang, the city’s largest district in which the bar is located, began a three-day mass testing campaign on Monday for its roughly 3.5 million residents.
People infected in the latest surge in cases live or work in 14 of the capital’s 16 districts, authorities have said.
Police have launched a criminal investigation into the person in charge of the bar on suspected interference with epidemic prevention, Pan Xuhong, deputy director of the city’s Public Security Bureau, told the news conference.
Sun made the remarks during an inspection tour of the COVID-19 prevention and control work in the national capital, where she visited sites hit by the latest wave of infections — two bars in Chaoyang District…
The quality and efficiency of work in various areas, including epidemiological investigation and transportation and isolation of cases, must be further enhanced, Sun said.
Beijing’s local government said a Covid-19 outbreak linked to a popular bar is proving more difficult to control than previous clusters, in a weekend that saw mass testing and rising infections both in the city and Shanghai.
Authorities delayed the reopening for most schools in the capital planned for Monday, while most districts in Shanghai suspended dine-in services at restaurants. Beijing reported 33 new local Covid cases as of 3 p.m. Sunday, all of which were found in quarantine. In Shanghai, cases continued to be detected in the community.
Beijing authorities have filed a criminal case against the owner of Heaven Supermarket Bar, which becomes the epicenter of a new wave of outbreaks in the capital, for impeding the prevention of infectious diseases. The license of the bar was also revoked, and it was listed as seriously breaching the law and conducting dishonest acts.
The recent outbreak was triggered by a customer of the bar last week who had not taken a test for 14 days prior. Beijing has been asking all its residents to undergo a nucleic acid test every two or three days, and if not, the health code will send notifications. People are also required to show their health codes before they enter any public places.
The “strict and fast” investigation of Heaven Supermarket, a bar in the Worker’s Stadium area of Chaoyang district known for cheap liquor and big crowds, will be conducted by a team of investigators covering several municipal authorities, including the health commission and the administration for market regulation, the official Beijing Daily reported Tuesday. Those found to have committed wrongdoing will be severely punished, the report said.
At least three cities in China, namely Beijing, Nanjing, and Wuhan, appeared to have shortened quarantine time by three to seven days for international arrivals on trial basis, which now only requires seven days of centralized quarantine and another seven days of home quarantine, the Global Times has learned on Sunday.
When the Global Times reached Beijing’s COVID prevention hotline on Sunday, it was informed that starting from May 15, Beijing has reduced again the centralized quarantine time from 10 days to seven.
It’s going to get worse and soon as the western consumer buckles and the mother of all trade shocks arrives in China. We are only seeing the front edge of it now:
As the Fed breaks the US consumer, and the US economy destocks its inventory mountain, a giant trade air pocket is coming to a Chinese economy already on its knees:
The final act in the great COVID cycle is a China crash.
David Llewellyn-Smith is Chief Strategist at the MB Fund and MB Super. David is the founding publisher and editor of MacroBusiness and was the founding publisher and global economy editor of The Diplomat, the Asia Pacific’s leading geo-politics and economics portal.
He is also a former gold trader and economic commentator at The Sydney Morning Herald, The Age, the ABC and Business Spectator. He is the co-author of The Great Crash of 2008 with Ross Garnaut and was the editor of the second Garnaut Climate Change Review.
