China: Growth and supply chains under pressure

U.S. GDP growth, quarterly (annualised)

40

30 33.8

20

10

0

-10 -5.1 4.5 6.3 6.7 2.3 6.9

-1.5

-20

-30

-40 -31.2

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 2020 2021 2022

Source: Bureau for Economic Analysis

China: Growth and supply chains under pressure

Following a relatively strong performance by the Chinese economy in 2021 with a growth rate of 8.1 percent compared to the relatively low basis value from 2020, expectations for 2022 have had to be pulled down.

Zero-Covid strategy restraining economic growth

While restrictions imposed to stem the spread of the pandemic are being lifted or reduced all over the world and the situation appears to be easing off, the Chinese government is sticking fast to its zeroCovid strategy. Strict lockdowns were imposed on several cities and regions in response to recent outbreaks of infections, above all in April and May. Production, consumption, supply chains and logistics have all suffered sustained damage. The economic indicators for these months are therefore correspondingly poor. The impact of these lockdowns has rippled across with world with effects being felt slightly later down the line in terms of time and beyond China’s borders. In Europe, the lockdowns have led to supply delays, scarce availability of certain goods and higher prices.

The Chinese economy started out the year with unexpectedly strong growth of 4.8 percent, buoyed by an upturn in industry and exports in January and February. The second quarter figures will show a pronounced slump in growth. The poor performance in March, April and May will have a prolonged effect on overall growth. The ambitious growth targeted by the Chinese government of around 5.5 percent is well-nigh out of reach even with massive economic stimulus and infrastructure measures. If the situation remains relatively stable for the rest of the year, annual growth could reach between 3.5 and four percent. In the case of more lockdowns or other economic shocks, growth could also well drop to below three percent.

Economic indicators mixed

In May, the lockdowns and Covid restrictions brought the national volume of freight and passenger transport tumbling down to around 39 percent compared to the same month last year. Industrial value added decreased by 2.9 percent in April, according to official figures, and is likely to have dropped on a similar scale in May. In May, the producer price index (PPI) was 6.4 percent higher than one year previously. Costs of energy in mining and commodities have risen in particular. The consumer price index (CPI), on the other hand, only showed a moderate 2.1 percent inflation. Costs for transport have risen particularly, going up 6.2 percent. Real estate sales were down by 39 percent on last month in April. In 47 of China’s largest 70 cities, new-home prices were lower than in the previous month. Consumption also plummeted on account of the lockdown. Retail sales for consumer goods were 11.1 percent lower in April this year than in April last year. The revenues of the large online retailers were even down by as much as 25.6 percent on account of supply and logistics problems. In May 2022, car sales in China dropped 12.6 percent, down to 1.68 million, following a deep slump of 47.6 percent in April. In the first five months of the year, car sales were 12.2 percent down on the same period in 2021. During the lockdown imposed on Shanghai, not a single new car was sold in the whole month. These figures indicate the scale of disruption to the Chinese economy. It remains to be seen whether performance will now pick up and make up for lost ground or whether supply and demand will continue to falter. A rapid bounce back in the retail and service sector is not on the cards in view of the low level of confidence among Chinese consumers.

Aggregated foreign trade for the period from January to May was at least up by a good 8.3 percent and is continuing to stabilise economic growth. Exports grew 11.4 percent and imports 4.7 percent. China’s official manufacturing purchasing managers’ index (PMI) which measures sentiment among the large state-controlled companies recorded its lowest value in the medium term of 47.4 in April. Although the index recovered slightly in May and climbed back up to 49.6 points and the PMI for services also improved considerably moving up from 40 points to 47.1 points, both indicators have remained under the expansion threshold of 50 points for months.

Announced fiscal and monetary policy measures

In April, the Chinese central bank (PBoC) announced that it would additionally reduce the minimum reserves of banks and dip further into the monetary policy toolbox in addition to indicating lower interest rates. In May, the over-five-year loan prime rate (LPR), on which many lenders base their mortgage rates, was reduced by more than expected from 4.6 percent down to 4.45 percent. The one-year loan prime rate was left unchanged for the time being at 3.7 percent.

In mid-May, the Chinese government reinforced its fiscal efforts once more and announced a number of measures and support packages. The prime minister, Li Keqiang, held an unprecedented nationwide online conference in which more than 100,000 officials from the central, provincial, and local levels participated.

The additional quantifiable measures announced at the conference amount to a volume of around 0.5 percent of GDP. That includes 200 billion CNY for additional tax cuts and discounts, a reduction in social security contributions of 200 billion CNY, and an increase in railway construction bonds of 90 billion CNY. The volume of support actually given will probably be larger as other measures, such as the increase of infrastructure investment and the support of housing demand, have not yet been quantified.

Higher infrastructure investment expected

At the meeting of the Central Commission for Financial and Economic Affairs Commission (CCFEA) in late April, indications were given that the government wants to scale up its infrastructure investment again. In the past, the combination of government debt and government demand has repeatedly been used to meet the growth targets set down in the annual plans.

The government is primarily planning to investment in regional airports, urban transport systems, ports and waterways, energy production and grids, healthcare and emergency services as well as oil and gas pipelines. These measures are designed to support economic growth in the short term and increase the competitiveness and productivity of China in the long term. These projects will only have the envisaged impact if the government first manages to completely contain the spread of Covid. Failing this, these additional investments may be too slow or too late to take effect.

Liquidity squeeze in real estate continues

Liquidity crunches already brought some property developers to their knees in China’s highly indebted property sector last year, most notably the construction company Evergrande. Although the sector has not collapsed completely as feared by some observers, the problems of the Chinese real estate market are continuing to plague the economy at large. Accounting for around one quarter of GDP when taken together with its impact on demand upstream and downstream, the property sector has until now been one of the most important drivers of growth. In view of the weak level of sales and strained financing conditions, the liquidity squeeze is set to continue.

International financial investors withdraw capital from China

At the start of the year, capital in the two-digit billion (U.S. dollar) range was drawn out of China. This affected Chinese government bonds, bank bonds and corporate bonds as well as shares. The main trigger for this outflow of capital was the draconian restrictions imposed in the country to combat Covid, the geopolitical effects of Russia’s war of aggression in Ukraine, continuing tensions between the United States and China and the aftereffects of regulatory interventions, above all in the Chinese tech sector. The volume of venture capital financing also turned down in the first four months of the year, dropping as much as 44 percent compared to the same period the previous year, down to 24.7 billion U.S. dollars. That is almost twice as high as the decrease registered in the United States and almost four times as much as the global drop in venture capital financing. In 2021, China stacked up a record volume of venture capital investments of over 130 billion U.S. dollars despite the harsh government interventions. The turnaround in interest rates set off by the U.S. central bank will now put additional pressure on China’s capital markets and could become a grave risk for China’s further economic development.

Political course

Back at the annual Central Economic Work Conference in December 2021, the government had already identified three main challenges for the economy which it then confirmed at the Two Sessions held in March 2022. These challenges are weak demand, supply shock and falling prospects. The latest economic figures underline this picture. The government is still sticking to security and stability this year even though its insistence on the zero-Covid strategy is having huge consequences on the economy.