China's road to economic recovery faces post-Covid speed bumps

(By Caixin journalists Yu Hairong, Cheng Siwei, Wang Liwei, Chen Bo, Wang Shiyu and Han Wei)

Just as the third year of the Covid-19 pandemic was drawing to a close, China's policy pendulum finally swung from stamping out and controlling the spread of the virus towards spurring economic growth, leaving everyone pondering: how will the world's second largest economy perform in 2023?

China in late November began abandoning most pandemic restrictions, ending the hyper-strict "zero-Covid" strategy that had taken an increasingly heavy toll on its economy and its people.

Excluding the first year of the pandemic, GDP in 2022 is estimated to have grown at the slowest pace since the 1970s according to economists surveyed by Bloomberg, with a soaring number of people failing to find a job. The youth jobless rate reached a stunning 19.9% in July, the highest level since record-keeping began in January 2018.

In the few short weeks since ditching the tough Covid-19 measures, policymakers have sent clear signals that the country would be emerging from its pandemic footing and the priority is now once again fuelling economic growth.

At the mid-December Central Economic Work Conference (CEWC), a key annual event to map out the economic policy agenda for the coming year, top leaders vowed to put stable growth above everything else.

The pivot comes with real urgency as China's economy expanded just 3% in the first three quarters of last year, compared with 9.8% during the same period in 2021. The slowing growth reflected the disruptions to business caused by stringent Covid-19 control measures as well as global uncertainties stemming from the war between Ukraine and Russia.

It is widely expected that China's growth was even slower in the last quarter and it will most likely miss the official full-year growth target of around 5.5% by a significant margin.

"It's not just a matter of speed, it's a matter of confidence," said Cao Yuanzheng, chairman of BOC International Research. Cao estimated that 2022 marked the first time since 1990 that China's economic growth will fall behind the Asian average.

Growth in Asia and the Pacific is expected to decelerate to 4.0% in 2022, before rising to 4.3% this year, according to the International Monetary Fund's Regional Economic Outlook published in October 2022.

Former US Treasury Secretary Lawrence Summers in August 2022 added to the voices of gloom, saying that previous predictions for China's economy to overtake the US may prove to be inaccurate.

"It was taken as axiomatic six months or a year ago that at some point the Chinese would surpass the American economy in terms of total GDP at market exchange rates," Summers said in an interview with Bloomberg News. "That's now much less clear."

But as China recalibrates its policies to focus on the economy, analysts are expecting a pickup in 2023, although they can't agree on how much.

"China's economy will see an overall rebound" in 2023, Han Wexiu, deputy director at the general office of the Central Financial and Economic Affairs Commission (CFEAC). The easing of pandemic restrictions, effects of pro-growth policies and the low base for comparison in 2022 will allow China to record higher growth in the new year, said Han, who did not provide a specific estimate.

Foreign institutions including Morgan Stanley, UBS Group AG and Nomura Holdings Inc. have all revised up their projections for China's 2023 growth since Covid-19 controls were ditched, adding between 0.4 and 0.8 percentage points to their previous forecasts. Predictions for China's economic growth in 2023 now range from 4.8% to as high as 8%, which would be roughly equivalent to the pace in 2021.

"It is certain that China's economy will rebound in 2023... the question is how much," said Lu Ting, chief China economist at Nomura. However, Lu warned against "excessive optimism", saying a growth rate prediction between 7% and 8% is based on the economy's potential growth momentum before the pandemic, which might have changed over the past three years.

The global economy will very likely slow down in 2023, with possible recessions in the US and Europe, adding more uncertainties to China's economy, said Lu. Meanwhile, the surge of infections after reopening and people's growing caution about spending will also constrain the recovery, he said.

Exports had been a major driver of China's economic recovery, but they have tapered off. For much of the period between July 2020 and July 2022, monthly exports rose by 10% to 30% year-on-year in dollar terms.

But since August 2022, that growth has slowed or even slipped into negative territory, as demand from the world's three largest importers of Chinese goods - the US, the EU and Southeast Asia - has weakened as high inflation weighs on consumers' purchasing power.

As external demand declines, policies to stimulate domestic consumption will be crucial, said the CFEAC's Han. The commission in December 2022 highlighted the importance of expanding domestic demand and for the first time put a higher priority on consumption recovery than stimulating investment.

Officials at the meeting pledged to implement a more forceful fiscal policy and targeted monetary policy to support businesses and domestic consumption. It also adopted more positive tones on the property industry, private sector and foreign investment, fueling expectations of more supportive measures to come in the new year.

Boosting confidence and expanding domestic demand will be the main principal driving Beijing's economic policies in 2023, China International Capital Co. Ltd. (CICC) said in a research note. More short and long-term policy arrangements can be expected to stabilise the economy, said the investment bank.

While the policy pledges made by the CEWC were as expected, "the market cares more about how the policies will be put into practice," a researcher at a brokerage told Caixin.

However, the task of "reviving and expanding consumption", as the CEWC stated explicitly, is likely to be challenging.

In the first 11 months of 2022, China's total retail sales shrank 0.1% from a year earlier, as disruptions from the pandemic and control measures cut into people's income. During that period, domestic consumption's contribution to GDP growth was 52.4%, sliding from 57.2% in 2019 before the pandemic.

As income growth has slowed, people have been saving more, said Li Xunlei, chief economist of Zhongtai Securities Co. Ltd.

Data from the National Bureau of Statistics (NBS) showed that Chinese people's disposable income grew at 5.1% annually on average between 2020 and 2021, compared with 7.1% from 2013 to 2019.

The growth rate then tumbled to 3.2% during the first nine months of 2022 as residents and businesses alike were rattled by widespread and repeated lockdowns across the country that at times saw hundreds of millions of people under some form of quarantine order, either at home or in centralised facilities.

A quarterly survey by the central bank found that over 58% of respondents wanted to save more since the second quarter 2022. The rate had never exceeded 47.6% before the pandemic.

Economists such as Morgan Stanley's Xing Ziqiang expect private consumption to become the main driver of China's economic recovery in 2023 as life returns to normal and income growth is revived.

But Nomura's Lu said household consumption won't recover anytime soon as many Chinese families, especially low-income households, saw their financial situation worsen badly over the past three years as their incomes were cut by lockdowns. For these people, returning to work and saving money has become more important than spending, said Lu.

The CEWC vowed to boost household income growth and support purchases of upgraded properties, electric vehicle (EV) sales, and elderly care services, indicating more policies will very likely be issued in 2023.

To unleash pent up domestic spending, the government should also increase public services and especially target the country's 300 million migrant workers who live in cities but have long been left out of urban education, health care and welfare services, said Liu Shijin, deputy director of the Economic Committee of the National Committee of the Chinese People's Political Consultative Conference.

China is expected to maintain strong fiscal spending in 2023, with the CEWC calling for a more proactive and effective fiscal policy.

This will require boosting the governments' fiscal income or a significant increase of the budget deficit, said Yang Zhiyong, a fiscal policy researcher at the Chinese Academy of Social Science.

China's budget deficit target was set at 2.8% of GDP in 2022, after recording 3.2% in 2021 and 3.6% in 2020. Economists have predicted a small increase in the 2023 deficit ratio to between 3% and 3.5%.

The CEWC said a mix of tools including fiscal deficits, special-purpose bonds (SPBs) and interest subsidies will be adopted to ensure fiscal sustainability and keep local government debt risks in check.

Some experts expect the government to expand the use of SPBs, an off-budget debt instrument issued by local governments and typically used to fund infrastructure projects. But others warned of repayment risks due to the huge size of outstanding debts.

By the end of October, outstanding SPBs reached 20.7 trillion RMB (US$3 trillion), according to the Ministry of Finance. During the first nine months of 2022, interest payments on the debts totalled 479 billion RMB, up 26.9% year-on-year, according to CELMA, a local government borrowing database.

China will increase borrowing through treasury bonds and regular local government bonds to provide funds to bolster people's livelihoods and consumer spending, while reducing the use of SPBs for infrastructure stimulus, said Chen Jianheng, an analyst at CICC.

The CEWC kept the "prudent" monetary policy tone with more "accurate and effective" measures.

Monetary stimulus in 2023 will at least be as strong as 2022, said Liu Guoqiang, deputy governor of the People's Bank of China, with support continuing for targeted areas such as small businesses and green development. The central bank will most likely extend some of the targeted lending tools launched during the pandemic after their expiration, according to Liu.

The beleaguered property sector may get some relief in 2023 as more supportive policies appear on the horizon.

The CEWC called for stabilising the real estate market, ensuring pre-purchased homes are completed, fulfilling developers' "reasonable demand for financing", effectively mitigating risks related to top developers and improving the condition of their balance sheets.

China has issued a sweeping set of measures over the past months to expand developers' financing and prop up home sales in hopes of arresting a protracted downturn in the multi-trillion-dollar property sector, which accounted for 22.5% of the country's GDP in 2021, according to a working paper published last month by the National Bureau of Economic Research.

An official at the CFEAC said more measures will be rolled out in 2023 focusing on improving developers' balance sheets.

Current measures targeting mainly healthy developers on the supply side may not be enough to reverse the market downturn, several industry sources told Caixin. More effective actions to benefit a broader range of developers including those already defaulted will be needed, said Lin Bo, general manager of China Real Estate Information Corp. (CRIC).

Economists have also called for more measures to boost home sales and revive developers' cash flows, without which the current bailout measures will only be temporary cures to stem the bleeding, while their inventories and debts continue to build up, said Zhong Zhengsheng, chief economist of Ping An Securities.

"More demand-side measures are needed," said Zhong.

Regardless of what actions are taken, a return of homebuyers to the market will not be imminent. China's housing prices and sales continued falling in November as transactions were hindered by Covid-19 outbreaks in major cities.

New-home prices in 70 cities, excluding state-subsidised housing, fell 0.25% in November from October, when they dipped 0.37%, NBSs figures showed. Sales dropped 31% from a year earlier, widening from a 23% decrease in October.

There were no signs of a recovery in sales in big cities in December, despite Covid-19 restrictions being lifted, one sales manager at a major developer told Caixin.

It will take time for public confidence to be restored and for households to adjust their family wealth plans, said the manager.

"A significant change in sales may be expected as early as June 2023," he said.

Improving market expectations and restoring confidence will be crucial for China's economy in 2023, according to the CEWC, as 2022 was a rocky year for private businesses, from property developers to internet platform operators, all were hit hard by the slowing economy and intensive regulatory crackdowns.

During the January to November period, private investment's share of total fixed-asset investment dipped to 54.6% from 56.4% during the same period in 2019. A survey by the Development Research Center of the State Council found only 16% of private companies were willing to make new investments, the lowest reading ever.

In an attempt to restore confidence, the CEWC reiterated the government's long-term commitment to supporting non-SOE development, welcoming foreign investors and investment, and underpinning the development of platform enterprises. Wang Tao, said chief China economist at UBS Investment Bank.

The reassurance will dispel some market concerns that China's government may no longer care as much about economic growth and the market, she added.

"With all the efforts to restore market confidence, the key is consistency and continued reform push," said Zhu Baoliang, chief economist of the State Information Center, a think tank linked to China's top economic planning body, the National Development and Reform Commission.

The primary task for 2023 is to prevent the anti-pandemic policy regime from spilling further over into the economy, said Liu Shouying, dean of the School of Economics at Renmin University of China.

"The system formed to fight the pandemic over the past three years, to a large extent, represented a return of the administrative system of governance and withdrawal from the market-oriented system," Liu told the annual meeting of the China Wealth Management 50 Forum last month.

"2023 should mark another round of China's market-oriented reform," said Liu.

This article was first published by Caixin Global as "Cover Story: China's Road to Economic Recovery Faces Post-Covid Speed Bumps". Caixin Global is one of the most respected sources for macroeconomic, financial and business news and information about China.

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