By David Mahon*
China’s economy contracted in July and August, mainly due to the tightening of the zero-COVID policy; More than 30 major cities are currently restricted or locked down. In the past three months, China’s GDP grew just 0.4% year-on-year, compared with 4.8% in the previous quarter.
An unseasonably hot, dry summer compounded China’s problems, reducing hydroelectric production in Sichuan province and forcing giant battery maker CATL and iPhone maker Foxconn to curb production. Since Sichuan generates 30% of China’s hydroelectric power, industrial production in neighboring provinces has also been reduced. Yunnan province produces 13% of China’s primary aluminum but is cutting production by 10% due to loss of hydroelectric capacity. A drought grips 80% of Hunan Province and with little rain forecast in the coming weeks, the region’s rice harvest could well fall by 50%. With the exception of wheat, China’s national harvest will nonetheless be good after years of government enforcing land-use rules requiring a high percentage of flat arable land to be planted with grain. Chinese citizens may not go hungry this winter, but many will be poorer.
Due to a slump in domestic and international consumer demand, a significant number of China coast manufacturers have reduced capacity and closed some factories. Concerned that the future supply of goods from China could be curtailed by the zero-COVID policy, international retailers are overstocking consumer goods in 2021, but as the cost of living continues to rise and consumer confidence in the West falls, key players such as Amazon Much of the excess domestic inventory will take up to 12-18 months to clear.
“We survived COVID well last year. I borrowed to increase our commodity inventories in anticipation that we would face similar demand this year, particularly from the US. I didn’t expect Omicron to last that long. After 20 years we closed the factory last month.’ Former lighting manufacturer, Hangzhou
“Compared to the previous year, we are 25% occupied. Still, I have trouble finding skilled workers. They tend to leave the company as soon as they think a company is in trouble. People talk a lot about unemployment and the loss of industrial capacity in the province, but good workers are finding jobs and vulnerable companies are being replaced by better capitalized ones. China has always struggled with overcapacity as companies opportunistically push into emerging sectors. This crisis is reducing capacity in our sector, which should be good for us in the medium term if we survive.’ Owner of an auto parts factory in Ningbo
World Bank and IMF assessments of historical Chinese GDP growth, industrial production and export data confirm that economic reporting over the past 10 years has been generally accurate. However, city and county officials are now under so much pressure to balance zero-COVID management with economic performance that some manufacturers, both state and private, are pushing to increase the production numbers they report — a practice that Xi Jinping until recently had reduced the imposition of harsh penalties for unscrupulous officials. As difficult as it is now to get a detailed picture, the trend is clear: the Chinese economy has shrunk, largely due to consumption falling amid strict implementation of the zero-COVID policy. The more developed provinces have been hit hard, with some struggling to achieve 2% GDP growth over the past three months. Resource-rich, sparsely populated provinces such as Ningxia, Inner Mongolia and Shaanxi are now growing more than twice as fast.
“It’s just political. Xi wants to ensure he can host thousands of delegates from across China to confirm personnel changes at the 20th National Party Congress. He will tie the country up to the end of the meeting, then perhaps politics will ease up. Most people expect they will. Without easing the zero-COVID policy, the economy will falter. I cannot imagine how the country will react if the zero-COVID policy is kept as it is.” Economic Analyst in Beijing
It would make sense for China to open up its domestic economy as soon as possible. The Government is aware that many people have lost confidence in local authorities due to the fearful and haphazard way in which they have applied COVID restrictions. Asymptomatic children have been separated from asymptomatic parents at quarantine centers in Shanghai, acute food shortages have emerged during the lockdown, and recently a bus fell off a mountain road normally closed to nighttime traffic after officials tried to force citizens out of the city to get in the early hours of the morning despite passengers having tested negative for COVID in the previous ten days. They happened to live in the same building as a couple of people who tested positive. Anger, contempt and sadness flooded social media.
It is not certain Beijing can risk opening up the country as it cannot accept a sharp rise in COVID deaths as it has already said it controls Omicron. Any relaxation of the zero-COVID guidelines will be gradual, with restrictions likely to remain in place until at least March/April next year. While it’s wrong to claim, as some do, that the party welcomes COVID restrictions as a tool of social control, given Beijing’s view that the world has failed to deal with COVID where China has succeeded, both are likely to tuck in humanitarian as well as a competitive motive behind current strategy.
“The perception in the cities is that the Chinese government’s COVID policies are unsustainable and Beijing has no choice but to relax the rules. But the government is looking at some alarming data. While immunization coverage in major cities is over 90%, of the 23% of people over 60 who live in rural areas, 52 million are unvaccinated. There would be an unsustainable death toll if they dropped the zero COVID policy tomorrow. The rules will not change until the virus weakens.” Public Health Analyst in Beijing
The Chinese government is doing everything it can to support the economy with increased investment in public infrastructure, lower interest rates, rent relief, a looser home buying policy and employment subsidies. However, the impact of this stimulus is hardly sufficient and the costs will weigh on future growth. Banks will struggle with high levels of non-performing loans as businesses continue to fail. Consumption is the main driver of China’s economy, but exports, which have drowned out anemic consumer demand for the past two years, are unlikely to do so in the next 12 months due to weak global demand.
The Chinese economy will remain, but at a cost that is accruing daily. Once COVID restrictions are eased, domestic consumption and foreign direct investment will revive economic growth. Foreign direct investment increased by over 17% compared to last year, with European, especially German, companies leading the way. The longer the Chinese government follows the current zero-COVID policy, the greater the cost of restoring public and economic confidence and the slower the recovery will be.
A nation of entrepreneurs
The economies of China and the United States are more alike than their conflict suggests. Both are driven by competitive domestic markets that encourage entrepreneurship and technological innovation, giving them better chances of renewal and recovery from downturns and recessions than their less dynamic peers. The difference is that the US focuses on international causes (real and imagined) for its current domestic economic weakness and social inequality, while China looks more at itself.
One hedge is that while the Chinese economy will be weighed down over the next two years by the domestic economic downturn and ever-increasing debt, banks are generally managed efficiently by the state. With the exception of a few rural and some municipal banks, bank lending is well secured – which is why even the collapse of real estate giant Evergrande has not created an unsustainable crisis for its institutional creditors. At 34%, Chinese household savings are among the highest in the world, and consumer liabilities are modest and manageable by OECD standards. An economy with a different balance of liabilities would already have entered a protracted recession.
The Chinese middle class is becoming increasingly rampant and shares many of the ills of the US and European middle classes, such as B. false entitlement and depression, while obesity and addiction are on the rise – but the good news is middle-class entrants from the underpaid masses are steadily swelling, totaling tens of thousands each year. These newcomers bring energy and innovation that drive and revitalize Chinese society and economy. Forty years of communism could not quell the Chinese people’s entrepreneurial spirit, and neither will a three-and-a-half to four-year pandemic.
The Chinese Communist Party and government appear to run the country uniquely, but they are also adapting to the powerful forces that underlie them. Although many officials, intellectuals and business leaders fear that President Xi Jinping is consolidating too much power around him, the masses of the people support his continued leadership. Xi may not bring economic relief immediately after the upcoming National Party Congress, but he knows he must offer a path to normality soon after. Xi will heed the economic and social pragmatists around him, because he too is a pragmatist. China will stumble into next year, but it will not fall.
*Mahon also recently spoke to interest.co.nz for an episode of the Of Interest podcast. You can listen to them here.
*David Mahon is Executive Chairman of Beijing Mahon China Investment Management Limitedwhich was founded in 1985. This article is here with permission.