- Macro Strategist
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The economy: A low bar for growth
Consensus expectations for China’s economic growth have not been this pessimistic in a generation, perhaps longer. With the bar set so low, it won’t take much for the Chinese economy to deliver an upside surprise in 2023.
China has experienced a maximum stress-test. For well over a year, a triple whammy of housing-related distress, zero-COVID lockdowns, and a generalized sense of policy angst have stifled consumer and business confidence (Figure 1). Amid massive pressure on multiple fronts, nothing has gone “bang.” One can never rule out a crisis event, but I believe China’s financial system has seen the worst of the stress and passed the test. Yet many observers still have a very grim outlook for the Chinese economy. I daresay even modest improvement would feel like a rebirth of sorts.
Confidence: The missing ingredient
Market liquidity is ample and financial conditions loose, but there has not been a corresponding pickup in banking system loans. And while broader measures of credit seem to suggest that the credit impulse is inflecting, there are few signs that China’s economy is responding to present fiscal and monetary easing. My view is that this response will likely come (and with it, improving growth) when confidence recovers, which could occur in the first quarter of 2023 as policy uncertainty subsides, COVID restrictions ease, and (hopefully) stronger action is taken on real estate. The real estate sector is, in my judgment, the single biggest factor weighing on confidence — even more so than zero-COVID.
Figure 1
The real estate sector: A pivotal factor
For at least the past decade, many commentators have criticized the Chinese government’s lack of action to rein in outsized activity in its all-important real estate sector. Last year, China’s policymakers finally did something about it, leading some to wonder if they may have gone too far. Consensus is now bearish overall, split between those who believe the sector might stabilize soon and those who think otherwise. I am in the former (minority) camp.
I believe the stimuli injected so far — mortgage rates and lending, monetary policy, pledged supplementary lending (PSL), and targeted assistance to property developers — should help the real estate market and put a floor on risk. Easy financial conditions and lower interest rates are already starting to spur demand. (Indeed, mortgage rates in China are now lower than in the US.) Stabilization of the real estate sector would enable a return of confidence, paving the way for a potential economic rebound.
Inflation: Nowhere to be found
Inflation is not an issue for China today, nor do I suspect it will be for a long time to come. In fact, I think China’s inflation is sufficiently well-anchored that even if it were to rise slightly (as it might), it would still not create much of a headwind for the economy.
Chinese core inflation is below 1% as of this writing, while the country’s low level of domestic demand and an absence of direct income support to consumers have kept the commodity price surge from impacting headline inflation to the same degree as in developed nations. Mild inflationary pressures should allow both fiscal and monetary policy easing to continue through much of 2023. Moreover, one silver lining of zero-COVID has been to suppress demand more than enough to prevent a widespread inflation problem from emerging.
Zero-COVID: In the rearview mirror
For the first two years of the pandemic, China’s zero-COVID policy was very effective in minimizing the number of infections and case counts, while maximizing the country’s economic output — until the Omicron variant appeared in late 2021. From that point on, maintaining the policy began to take a heavy toll on the economy. In light of this major trade-off, it became increasingly clear to China’s government that adhering to its current policy stance was more or less incompatible with its economic and social objectives.
In November 2022, pandemic containment measures — lockdowns, isolation, contact tracing — were overwhelmed by a large number of infections. This forced China toward a policy shift, easing restrictions even as case counts rose and accelerating vaccination rates for vulnerable populations. However, the virus spread much faster than anyone (including most epidemiologists) expected. By the first week of January, some provinces and most tier-one cities reported that between 70% and 90% of residents had already experienced COVID. Shortly thereafter, the government liberalized international travel and reopened China’s borders for quarantine-free travel.
While the surge in cases did put an enormous burden on China’s health care system, both empirically and anecdotally, the COVID fatality rate has remained low relative to the global pandemic waves of 2020 and 2021. Notably, so-called “hybrid immunity” is being achieved much faster and with much less disruption than anyone anticipated. As a result, I believe economic and other activity is likely to fully resume by the end of the first quarter of 2023. The markets, meanwhile, are already looking toward this eventual “renormalization.”
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