China’s economic recovery hinges mostly on its Covid policy

On a trip to Wuhan in late June, Xi Jinping once again reiterated that China’s “zero Covid” policy remains the “correct and effective” strategy and should be maintained “until the final victory is achieved”, even though that might mean “temporarily impacting economic development”.


He made these remarks, seemingly fully aware of the heavy toll the strict Covid measures are exerting on the economy. After a surprisingly dynamic first quarter with GDP growth of 4.8%, the weakening signs in March were confirmed in the April data. On the supply side, industrial output dropped by 2.9%, infrastructure investments grew by only 1.8% and exports by a low 1.9%. The demand side suffered even more, evidenced by retail sales contracting by 11.1% and property sales by 39%. In recent years, corporate investments have contributed up to half to GDP, household consumption including real estate another 35%.


In an online event for Party officials on 25 May, Premier Li Keqiang warned his comrades that the difficulties “are greater than those experienced in 2020”. Urban unemployment overall had risen to 6.1% and youth unemployment amongst urbanites even to 18.2%. Last week, when meeting local government officials from five coastal regions in Fujian, he told them the country stands at a “critical” point in economic recovery, and called on these five economic powerhouses and manufacturing hubs that contribute one third to national GDP – Shanghai, Guangdong, Jiangsu, Zhejiang and Fujian – to carry a heavier load and “exhaust all means” to stabilize production and employment.


To stop the negative trend, a new round of stimulus unveiled in May shall “get the economy back on a normal track” in this pivotal year ahead of the 20th Party congress. Among the six types of measures in the 33-point package issued by the State Council in late May (cf. slide), the government vows to top up VAT tax rebates, provide further relief for social security and other business costs, or provide additional loans for infrastructure projects. A few days earlier, the Shanghai Municipal government had issued its own list of 50 measures to help the city’s economy spring back to life after the lockdown.


Besides tax and fee relief measures, the government is particularly using infrastructure to support businesses and jobs, increasingly focusing on ”new infrastructure” such as industrial internet and big data centers. Beijing has urged local governments to issue all special purpose bonds (SPBs) earmarked for 2022 (3.65tn yuan) already by end June and spend the proceeds latest by August – a significant front-loading. SPBs are a financing tool for local governments, mostly used to finance infrastructure projects. It is assumed that on top of that, 1.5tn yuan will be made available from the 2023 budget for the second half of 2022. The State Council announced on 29 June an additional 300bn yuan to finance infrastructure projects, coming on top of the 800bn yuan policy bank loans made available earlier. China further announced a state infrastructure investment fund worth 500bn yuan.


All these measures are still far away from the stimulus package issued in the wake of the Global Financial Crisis in 2008-2009 totaling 4tn yuan though, and are testament to the wariness of economic policymakers of the fiscal realities. Fiscal revenue in May contracted 33%, after a 41% decline in April, raising the budget deficit for the first five months above 1tn yuan. Foregone tax and fee revenue as well as the additional expenses for Covid testing and other measures require especially local governments to further tighten their belts, while trying to ensure “zero Covid” and simultaneously stimulate growth.


After three months of economic contraction, Shanghai began to reopen on June 1st, and Beijing also started to resume normal life. June numbers and economic data for the second quarter are not out yet, but indicate that economic activity is coming back to life. The Caixin Manufacturing PMI reading at 51.4 in June for instance indicates that businesses have been resuming work and order inflow is on the rise again. Still, much more than 1.2% growth for the period April to June looks unlikely.


And despite industrial activity resurging, the core problem for policymakers remains a severely dampened household consumption. Finances are strained, and people still rather save than spend the money. What is more, with inflation burdening the economies in the US and Europe, China’s export sector cannot count on these markets yet again.


The biggest lever the Chinese government has to help the economy recover across the board remains its Covid policy. Under the current policy, however, the perspective of new lockdowns due to the new BA.5 variant will keep consumer confidence low. At the moment, however, large parts of the elderly still remain insufficiently protected against the virus, potentially risking the lives of up to 1.6m people if restrictions were to be loosened, according to a recent study by Shanghai’s Fudan University. Another problem: With lockdowns and mass testing absorbing health care resources, the vaccination rate has been slowing from 5m shots per day in February/March to 1-2m shots per day in April. At the current vaccination rate, therefore, no significant policy easing can be expected at least until end 2022.


Beijing is, however, now tweaking some of the specifics of its Covid policy. Per a State Council notice of 27 June, the quarantine time for foreign arrivals has been cut in half from 14 to seven days, the testing frequency reduced, and the discretionary rules for regional lockdowns standardized.


Despite such “cosmetics”, and understanding that China’s economy would need to grow by 7% in the second half of the year to still reach the 5.5% annual target set in March, a GDP growth of above 4% would be a surprise for 2022.

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