The Chinese economy has faced intense challenges over the past year because of the Omicron outbreak, which is expected to result in a much lower GDP growth rate for 2022 than the one initially targeted by the government. Against this backdrop, and in the light of growing protests and disruptions in the countries’ major factories, particularly Foxconn, China suddenly chose to swiftly move away from zero-Covid in late November, which has led to a massive increase in Covid cases.
The November data has turned out to be even worse than expected, due to even lower mobility as lockdowns accumulated prior to the opening-up. The December data will probably be very poor too, but for a different reason. A wave of cases is bound to stop production in factories and heavily slow down the provision of various services. The first quarter of 2023 could be difficult in more remote provinces, but the largest cities will probably peak before the Chinese New Year. This means that pent-up demand should start pushing up consumption in a few weeks and especially from the second quarter of 2023. Investment sentiment may take longer to fully recover. This is not only because of investors’ cautious attitude towards the opening-up but also because headwinds remain, both on the external front, in the form of rapid deceleration in the US and Europe, and in the real estate sector, with continuing double-digit negative growth in home sales. Furthermore, China’s external demand is plummeting as clearly shown in the November export data, and it is hard to see a recovery in 2023, certainly not within the first half. That said, we still expect China’s GDP to enjoy a fast and significant rebound in 2023 because of the low base in 2022 and pent-up demand. This equates to GDP growth reaching 5.5% in 2023. This surge in growth, though, is still rather limited compared to the exit from the previous pandemic wave in 2021 (8.1%) and is bound to decelerate structurally thereafter so that our projection for 2024 comes down to 4.5%.
The economic acceleration will exert upward pressure on demand-induced inflation in 2023, especially for food prices in Q1 due to the low base this year. But the rising momentum of food prices will fade for the rest of the year as the base effect falls. Also, both China’s PPI and export unit price have also been decreasing in recent months, signalling headwinds ahead. As such, we only expect inflation to moderately increase for 2023.
The PBoC is likely to have more room to manoeuvre its monetary policy thanks to low inflation and also the likely peaking of the Fed’s hiking process in March 2023. However, it will still be cautious, as the current interest rate is already low in China. Since the key to supporting China’s growth is to channel liquidity into supporting growth, the PBoC will focus more on injecting funds to maintain the current liquidity rather than to pushing the interest rate significantly lower. In the meantime, the Chinese authorities will also continue to impose capital controls to avoid large capital outflows. Against this backdrop, we may start to see some rebound in the RMB as the dollar starts to moderate after Q1 2023.
All in all, 2023 should be a reasonably positive year for the Chinese economy, certainly when compared with 2022, but this benign scenario is not free from major risks. The most obvious and immediate one relates to a chaotic exit from zero-Covid policies. The lightning speed at which China has opened up after three years of zero-Covid policies has led to a massive surge in cases. This is particularly worrisome given the still rather low vaccination rate for the elderly (less than 40% of people over the age of 80 have received a third dose). Furthermore, the limited scope of China’s health care system increases the chances that a very difficult health situation may reverse the opening-up or, simply, collapse China’s production capacity. This tail risk would have very significant consequences for the rest of the world, as China is the world’s largest exporter and plays a central role in the value chain. In other words, supply chain disruptions and renewed pressure on global goods prices cannot be ruled out. The second risk could stem from the property market, if the current support measures do not fully work. Given that the exiting measures are targeting the healthiest developers, there is still a chance that more developers will default, with negative consequences for China’s financial system. Thirdly, Chinese local government finances could further worsen if their revenue does not significantly recover or there is a surge in fiscal expenses related to a swift, but difficult, opening-up. Fourth, the US-China geopolitical situation may deteriorate further, as can already be seen from the additional containment measures taken by the US in the last few days and in October with the semiconductor export ban.
All in all, the Chinese economy should do better in 2023, due to the positive base effect and pent-up demand released by the exit from Covid lockdowns. However, risks are piling up, especially in relation to the exit from Covid measures, which could end up being less smooth than originally expected.
