Speakers: Paul Diggle, Bob Gilhooly

Paul

Hello and welcome to Macro Bytes the economics and politics podcast from abrdn. My name is Paul Diggle Deputy Chief Economist here at abrdn. And today we're talking about China's post COVID reopening - why the sudden change in policy? How bad was the initial economic and health hit? But then how strong will the rebound be domestically and indeed, globally as China transitions to endemic living? So. it's a big and fast-moving topic, which is very much a crucial macro and market driver in 2023. And I'm delighted to be joined by my colleague, Bob Gilhooly, who is our Senior EM Economist and resident China expert. So, Bob, let's start with why China transitioned so quickly from its strict zero COVID policy, to an easing of essentially all restrictions in late November, early December. What drove that dramatic policy pivot?

 

Bob

Yeah, thanks, Paul. I guess we can't really pin the decision to reopen on any one specific factor. But three things really stand out to me. First of all, it was getting increasingly difficult to contain the latest Omicron variants that were going around China, given their exceptionally high transmissibility for a large number of provinces, registering outbreaks, and really, if we were going to see the authorities try to kind of reduce cases numbered back down to zero, that probably would have necessitated, you know, very harsh prolonged lockdowns across many different cities and provinces. Secondly, the cost to local governments of containment was clearly rising. Some provinces were spending in 2022 probably as much as they did in the previous two years while lockdowns, weak growth and the struggling property sector were all squeezing revenues on the other side of the fiscal ledgers. I think politics here was also important. We were past 20th party congress, with President Xi securing an unprecedented third term, perhaps more significantly, though, the eruption of anti-lockdown anti-communist party protest was kind of the most visible sign of public discontent with the government's policies that we've seen basically in the last 30 years.

 

Paul

And did we misunderstand quite how responsive Chinese policymakers were going to be to those street protests? It strikes me that that was the misreading that many in the West made - that somehow the political system would not change direction in light of changes in public opinion. Was that a crucial kind of misunderstanding do you think?

 

Bob

Yeah, I think that was probably part of it. But I’d probably say the surprise here was maybe a little bit broader than just the public protests. I mean, we do seem to have had effectively, you know, an abrupt change in the willingness to trade off public health against these political considerations, and growth. I think what was surprising here was clearly Omicron is less dangerous, and harder to contain - we knew that at the start of 2022. But that doesn't mean it was necessarily undangerous for the under-vaccinated elderly population, as the experience in Hong Kong had demonstrated before. I think that implied that change in policy would only really happen after vaccination rates had been raised, and maybe healthcare in rural areas had also been improved. The Communist Party had I guess also just spent so long emphasising the dangers of COVID with communications, you know, drawing a very stark contrast to those in the West, which had been kind of relatively costly in terms of lives. I guess, we probably thought there was just kind of less risk tolerance there, as well, in terms of the kind of public health outcome and I guess the kind of final move away from zero COVID was also in many ways a kind of de facto abandonment, rather than a kind of clearly thought through, well communicated policy change that had followed in any way a roadmap moving towards endemic living. And you know, I think when people look back on this, the question is going to be one more of the degree and relativity of this maybe of this policy mistake rather than whether one was made at all.

 

Paul

So do we have a good handle on how severe the initial COVID reopening wave has been? And indeed, how big the initial macroeconomic hit was as well?

 

Bob

Well I guess we can't really be 100% sure, given testing was effectively, you know, completely abandoned. So there are quite a lot of doubts about the death numbers too. The bar seems to have been set very high recording deaths as related to COVID within China. I think the picture we're getting from unofficial and official surveys and estimates is really kind of one of an exceptionally rapid COVID wave that may have peaked towards the end of December, and then eased notably, through January. I mean, I won't go through all the facts and figures here, but China's National Health Commission reported that visits to fever clinics peaked at a bit under 3 million on December 23. That's back down below half a million. Internet search data also paints a picture - certainly one of fading concern by households. And survey data, you know we had research from Gavekal reporting the 80% of respondents to one of their recent surveys had said they'd already had COVID. Now that seems exceptionally rapid by the standards of other countries reopening. But, you know, our colleagues on the ground in China can back up this picture of an exceptionally fast wave with most people, you know, having had COVID.

 

Paul

Yeah, so we're operating at a data vacuum. But this kind of ‘anecdata’ very much confirms the idea of an extremely rapid spread, which I suppose is what we should expect in a population which didn’t have natural immunity which was faced with an extremely transmissible variant of the virus. But of course, Bob precisely because the spread has been incredibly rapid, it seems like the economy has moved through that deep initial growth hit into its rebound stage pretty quickly. So what are you seeing and tracking in terms of the macro improvement now that we're kind of more into the endemic living phase?

 

Bob

Yeah, I think you're right, you know, we can sort of debate about whether Chinese GDP really did contract or not in Q4, but that kind of feels like ancient news now. Markets are definitely looking forward. The lack of any attempt to really flatten the curve and take pressure off the healthcare system, combined with households making the most of their new-found freedoms does seem to have generated a very rapid rebound – and one that we actually believe began in December. You know, some of the indicators show, for example retail sales volumes, we think they rose about two and a half percent month on month in December. That's painting a picture of a recovery already gathering pace. That said, soft and high frequency data also confirms a kind of ongoing bounce - one that looks like it's accelerated through to January too. So we just got China’s January NBS non-manufacturing PMI out this morning, which jumped from 42 to 54 with ‘expectations bounce’ hitting almost 65, which is the highest reading we've seen there since 2012. High frequency data for Lunar New Year also backs up the view of a very rapid recovery too. Ministry of Culture and Tourism reported that domestic visits were almost at 90% of pre-pandemic levels, other kinds of indicators, such as the Baidu Migration Index, which is a bit akin to Google Maps, if people are more familiar with that, actually points to potentially stronger inter-city travel this year than we saw in 2019. And the China Cuisine Association also reporting that catering may have rebounded to a level slightly above that seen in 2019. So really, Chinese households do seem to be making the most of this opportunity to visit friends and family that they haven't seen, for in some cases, for several years now.

 

Paul

And then Bob you’ve just updated your China GDP forecast for 2023 as a whole, indeed in the Research Institute we’ve just done a global forecast, refresh. China was a big moving part. Do you want to explain what you are now forecasting for Chinese GDP in 2023 as a whole?

 

Bob

Yeah, we've really had a big, big upward revision. We're now a bit above consensus, penciling in around about five and a half percent GDP growth for 2023. Consensus is still around about about 5.1. And our view is it's really going to be a consumption and services driven rebound. You know, some commentators have been flagging a very exceptional rise in bank deposits, and the potential for quote, unquote, ‘revenge consumption’, which I believe is probably a dish best served hot in this case, but we don't really need to kind of like appeal to this revenge consumption idea. There's a bit of a thought experiment. Just simply returning the savings rate, or equivalently, the consumption rate out of disposable income back to prior norms, you know, that should be enough to drive nominal consumption growth, to rise by about 14% in 2023 versus 2022. And if households were to tap, what we estimate to be a roughly 4.2 trillion worth of RMB, which is about 3.7% of GDP, that they've saved out of disposable income since the start of the pandemic, that could potentially push nominal consumption growth closer to 20%. Now, I would say that, you know, we do think that the distribution of savings is skewed towards higher earners which kind of tempers this upside risk - as does the potential for kind of stronger services inflation, to kind of curtail what's really going on in the real side of the economy. And I guess spending could be leaking abroad, more than we expect via tourism too. So that's one of the reasons we're very confident about the consumption rebound plus that very V shaped recovery we were discussing and that kind of high frequency data too. I guess, you know, we do still expect consumption to be supporting the goods and manufacturing side of the economy, to some extent, but it's less clear, I think there's really a large pent up demand for goods and we also expect the external environment to worsen, as the US recession saps export demand around the middle of the year. So on that kind of manufacturing, secondary industry side of things were a bit less confident, but maybe some sort of near term momentum should really help cement China’s recovery for the first half of this year, at least.

 

Paul

One of the features of the reopening rebound phase and in other economies has, of course been that they've been inflationary. Demand has returned more rapidly than supply. And we are now living with some of those inflationary consequences. How do you think about inflationary dynamics in China during the reopening then?

 

Bob

Yeah. I think there are probably a few key differences here. One is China's clearly coming from a position of excess slack. Growth was exceptionally weak in 2022. I think having a desynchronized timing with the rest of the world will also help in terms of other economies coming out of lockdown and moving to endemic living. This was kind of a period of quite synchronised strong growth, still strong demand for goods as well, which has really put a big stress on global supply chains. In contrast, now, the picture for global supply chains is one of marked improvement. We do think that consumption is rotating away from goods and more towards services, in developed markets too. Again, kind of speeding up that global supply chain recovery. So we're not really too worried, I guess about the kind of goods prices surprising on the upside for China. I think a bit of an uncertainty here is around how strong the services inflation will be. I think the moderating goods inflation combined with stronger than normal core inflation is going to push up inflation in China in 2023. But on the other hand, you know, one of the difficulties judging the current outlook for the world economy is penciling in the US recession implies a big downward shock, potentially coming through oil and other commodities at some point too. So that should net off and keep actually headline inflation relatively modest - even if we do get some core services inflation bubbling underneath the surface in China.

 

Paul

Yeah. So divergent global growth trends an important driver of what happens in Chinese price developments as well. But you've got a forecast of five and a half percent GDP growth for China this year, the strongest growing major economy, it's above consensus, perhaps the risks lie to the upside as well. What do we think then about the supposed pro-growth pivot in other areas of Chinese policy for example, in the housing sector? Is there going to be appetite to provide infrastructure stimulus, credit support, revive the housing sector? How do you think about those issues?

 

Bob

Yeah, I mean, you're right. The authorities have been striking a fairly pro-growth, kind of open for business tone more recently, by I find it actually quite hard to believe that they're really going to keep their foot on the gas as the economy rebounds. You know, I mentioned a bit earlier, local authorities have got some pretty large fiscal holes to fill. The weakness in the property market, you know, pulled down land sales, typically a notable source of revenue. And all this implies acts that are more likely to tone down some of their infrastructure spending and that's going to net off some of the recovery in private construction, as the real estate market kind of picks up and gets going. I’d probably say the rhetoric on policy often seems a little bit stronger than the actual kind of details that are coming out in terms of the policy announcements too. The pivot on real estate, I think should be good for kind of solvency for the developers. Should be good as well for ensuring homebuyers actually received completed projects, completed houses, which is clearly crucial for getting the pipeline of activity going in the real estate sector again. But that still implies to me the implications for activity are a little bit more modest. Last year's drop in new starts was so sudden, I think that's still likely to weigh on investment over the course of this year, given the lags between effectively breaking new ground, on building projects, and then actually kind of the investment flow is associated with it until you hit project completion. And then, you know, generally, I think the authorities are going to be quite wary of losing progress made today on de-risking the economy, de-risking the financial system, and also de-risking the real estate sector. I mean, the latter, I think, has become even more of a focus, given the long run challenges here China faces from demographics. You know one of the numbers that came out with the Q4 GDP release was that China’s population fell for the first time in 2022. And while urbanisation upgrading should be, you know, supporting new builds and still providing some impetus to the property market, the accelerating fall in population is going to bite at some point. The UN expects China's population to fall by staggering 655 million by the end of the century so the risks of a kind of property overhang is clear. So I think they've got a bit of time before this becomes a real issue – but by the time we get to sort of 2040 this could be a very difficult challenge for the policymakers - and another reason to think you don't want to lose sight of de-risking the economy and kind of returning to the boom bust cycles that we've seen so many times around credit in China.

 

Paul

So in a way the progress pivot was dropping zero COVID so why add to that with kind of old fashioned infrastructure splurges or undoing the good work that started in terms of China's multi-year real estate adjustment. But let's think about the rest of the world - how China reopening impacts or can transmit to growth and inflation elsewhere. The positive, as it were, channels, Bob. Is it all a tourism story – or is China going to be demanding a lot of commodities and global goods from the rest of the world as well?

 

Bob

Yeah, I mean, I think you mentioned tourism there. And I think more generally, there's quite a lot of reasons to think that kind of the unique features of China's reopening means that kind of normal channels that you'd think of in terms of spillovers from China's growth to the rest of the world, don't quite operate as they might do in kind of slightly more normal times. First of all, composition of growth in this recovery should likely be much less import intensive. Input/output tables would suggest that consumption is around about kind of two thirds of the import intensity of investment. And that could be even lower if services is a large share of that kind of consumption rebound, which is what we expect. Clearly, return of Chinese tourism from effectively zero is a fairly good positive sudden boost for many countries. Thailand, I think really stands out here. But Malaysian GDP also should get a moderate boost as a result too. For other countries, though the return of Chinese tourists is probably welcome from an activities perspective, but we need to put it into a bit more context, In APAC countries are normalising towards tourism deficits, and that process still has some way to go. So while kind of China's 170 odd million tourists will be welcome for the money they bring, the potential to put an upward pressure on services inflation, which for some countries might be just running a little bit uncomfortably too hot complicating the job of central banks and you know, potentially even meaning slightly higher rates, or higher for longer, to get inflation back to target consistent rates. I mean, we mentioned the commodities channel a little bit before and I think one of the big questions is whether the oil markets are really factoring in the return of both international and domestic travel in China. Before the pivot away from zero COVID, domestic travel in China was only running around about a quarter of the pre-pandemic norms as people were rightly concerned that they'd be effectively kind of stuck in quarantine, if they went to other parts of the country. So you know, that kind of domestic travel rebound alone could be a fairly big driver of marginal oil demand and raises more questions about whether, you know, oil will or won't be as much of a disinflationary force over the coming years.

 

Paul

Yes. I think the inflationary consequences of Chinese reopening are crucial because there are these clear positives especially through tourism channels for parts of the world, Southeast Asia, perhaps through commodities demand into Latin America. But for those parts of the global economy where the issue is overheating, and an excess of demand over supply, the addition of a whole new source of demand into the global economy, a kind of a reopen China, unleashed Chinese consumer, is not a positive – and in a way, rather than cancelling out so preventing our long-standing US recession call, it even plays into it by adding to over demand issues, so that's why I very much think of it as it's not like the post financial crisis where Chinese stimulus was a type that lifted all boats. Instead, it's a source of divergence in the global economy for 2023. But I want to close then on a thought about policy swings in China, in an opaque political system. And the COVID policy pivot as an example of this albeit one that's probably quite, as we've discussed, a big boon for domestic growth. But there have been others around education technology, perhaps in the future, there'll be around geostrategic policy that could introduce significant volatility into markets. So is policy risk, a growing risk in China, especially in the context of Xi’s cemented central power?

 

Bob

Yes, I think it is. I think you put it very well, it's the opacity of the system just makes it very difficult to know, I guess whether policies are durable and stable, or whether they're actually at risk of suddenly becoming a focal point for the government, dramatically changing the business environment there. I mean, in terms of the kind of the authoritarian system or China’s political system more broadly, you know, there's a few factors there that kind of, probably feed into this sudden policy change risk. There's, I guess, there's no equivalent of kind of think tanks or open discourse on the kind of pros and cons of policy, which investors or others can use to help kind of guide expectations. The legal system doesn't probably create the kind of grit that's in the Western countries, that kind of might slow down policy changes. And, you know, authoritarian systems, more generally kind of have a tendency for some power consolidation. You're putting more of the decision making at the top, or perhaps depending on the system, skewing the information flow to the top two. And that could potentially contribute to your policy being maintained for longer than it should have otherwise been, and then lurching in a new direction. And there isn't really much sign I think, within China, that there's going to be any fundamental change to the Chinese political system - if anything, you know, powers become more concentrated. And these risks are arguably higher than they used to be, say, 5 or 10 years ago. I mean, what does this mean? Well, for investors, it certainly makes the job harder. They’ll be relying slightly more on kind of rumours and conjecture than they would be otherwise and that contributes to fairly violent swings in sentiment with or without policy changes to back them up. And you pair the opacity of the Chinese system, with a rapidly changing economy, added on with global geopolitical tensions, you know, we should be effectively thinking of this as needing to kind of be pushing up on the risk premium of Chinese assets. To put into more layman's terms, you know, there's good reason to kind of expect the unexpected within China, as an ongoing kind of structural feature.

 

Paul

Brilliant, Bob, well put - and thank you for your insights. And thank you to you for listening to Macro Bytes, as ever, please like and subscribe on your podcast platform. But until next time, good bye, and good luck out there.

 

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