Pinning hopes on a resurgence in Chinese demand — to offset economic weakness elsewhere — is misplaced
People cross a street in the Jing’an district in Shanghai on Dec. 21, 2022. Photo by Hector Retamal/AFP via Getty Images After a disastrous 2022, China should experience a pick-up in growth next year as COVID-19 controls are eased, but the related benefits may not be as good as advertised.
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For starters, it’s unclear how much freedom of mobility Beijing will be able to offer given the likely surge in new infections (stemming from reopening) due to poor vaccine efficacy. Even absent additional government restrictions, citizens themselves are more likely than not to self-regulate amid rising infection risks, thereby restraining consumption as a result.
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While the end of China’s lockdowns will further ease supply chains and add to worldwide disinflationary pressures, related growth benefits are unlikely to be enough to prevent a global downturn in 2023. That’s a warning to investors not to get complacent amid talk in the media of a soft landing for major economies, and to take a defensive posture by steering clear of cyclical stocks while adding high-quality bonds to the portfolio.
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‘Zero COVID-19’ policy relaxed After months of protests by lockdown-weary citizens, China’s government has finally agreed to step back from its zero COVID-19 policy. Requirements for COVID-19 testing, tracking and quarantines have been relaxed, while the reopening of borders for international travellers is reportedly being considered. All of this is happening despite new infections remaining elevated at well over 20,000 per day.
People line up to buy COVID-19 antigen test kits t a pharmacy in Hangzhou, Zhejiang province, China, on Dec. 19. Photo by China Daily via Reuters The relatively low COVID-19-related death count (close to zero) seems to be giving Beijing a high enough level of comfort to adopt the rest of the world’s “living with COVID-19” mantra. The government also seems to be confident that its earlier measures to bolster health care (for example, increase vaccination of the elderly, stockpiling medical equipment and treatments) will work as intended.
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Article content Pent-up demand restrained On paper, this relaxation of restrictions should help rekindle economic growth as activity slowly returns to normal and pent-up demand is unleashed. But given Beijing’s previous stop-and-go approach, one can’t help but be wary about the possibility of lockdown restrictions making a comeback, especially if fatalities start to rise again.
Indeed, increased freedom of movement — such as allowing people to quarantine at home instead of quarantine centres — makes it easier for the virus to spread, especially in areas of high population density. That, combined with poor efficacy of domestically produced vaccines — which partly explains why new infections remain elevated despite a full vaccination rate of nearly 90 per cent — and an upcoming increase in travel in January related to the Lunar New Year, will put additional strain on the health-care system, likely leading to an increase in COVID-19-related fatalities.
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Article content It’s unclear what fatality rate Beijing would be willing to tolerate, but one should never underestimate the government’s resolve (and power) to bring back lockdowns if deemed necessary.
Another factor that may limit the economic benefits of reopening is self-regulation. Knowing that vaccine efficacy is poor, individuals are more likely than not to limit exposure by curbing their own mobility, which translates to less money being spent than would otherwise be the case.
A worker sits next to waste material outside a fever clinic in Beijing, on Dec. 19. Photo by Noel Celis/AFP via Getty Images Regardless, the financial health of households has taken a beating after the country’s real estate meltdown (about two-thirds of household savings is reportedly tied up in real estate) and the lockdown-related economic slowdown, which limited hours worked and disposable incomes.
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Article content It’s true that thanks to relatively low inflation, the People’s Bank of China has room to stimulate demand. But despite a string of accommodative policy measures this year, the uptake of credit has been rather modest. Household loans have risen by 3.65 trillion yuan in the first 11 months of 2022, just half of the tally registered for the same period in 2020 and 2021.
Clearly, it takes more than just lower interest rates to stimulate borrowing. Consumers also have to feel optimistic about the future and, based on the record low confidence index, they aren’t.
Simply put, consumption spending, which has yet to recover from the lockdown-related collapse, could remain depressed for a bit longer as weak disposable incomes and low confidence take the edge off any existing pent-up demand. That, coupled with ongoing real estate woes, does not bode well for the domestic economy in 2023. That means trade, whose influence over the economy has grown in the past three years, is likely to remain crucial for overall growth, at least during the near term.
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Article content A woman and a child wearing face masks ride on a swing outside a reopened shopping mall in Beijing. Photo by Andy Wong/AP Photo The good news is that the yuan’s competitiveness has significantly improved this year, with the real effective exchange rate dropping to its lowest level in almost three years thanks to nominal depreciation and lower inflation rates than China’s trade partners. The bad news is that exports are vulnerable to a global economic downturn, which is becoming more likely after unprecedented policy tightening by world central banks.
The dull overall outlook suggests China’s rebound from a disastrous 2022 will be muted at best. No wonder reputable forecasters expect China’s real gross domestic product (GDP) growth to remain well below the pre-pandemic pace of six-plus per cent (4.4 per cent, according to the International Monetary Fund and 4.6 per cent based on the latest Organization of Economic Co-Operation and Development forecasts).
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Article content Opportunities That’s not to say there won’t be opportunities in China. Notwithstanding near-term challenges to growth, the productivity gains stemming from ongoing automation cannot be ignored for investors seeking long-term returns.
The country is the world’s fastest-growing robot market and has the largest number of installations per year. Robot density last year even surpassed that of the United States for the first time with 322 units per 10,000 employees in the manufacturing industry — now fifth in the world after South Korea, Singapore, Japan, and Germany. And that has helped keep prices grounded.
True, weak demand and excess capacity are largely to blame for low inflation, but the industrial capacity utilization rate of 75.6 per cent in the third quarter is similar to what it was back in early 2017 when core inflation was about two per cent, more than double what it is currently. In other words, productivity gains are also working to keep prices low and Chinese manufacturing products competitive.
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Article content Bottom line All told, China’s reopening may not be as beneficial to the world economy as you would think. The risk of lockdowns making a comeback cannot be underestimated given the likely increase in COVID-19 infections and fatalities amid poor vaccine efficacy. Pent-up demand from consumers may also not be as potent as advertised, considering the loss of wealth from the ongoing real estate crisis and weak growth in disposable incomes.
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Low inflation and accommodative monetary policy are, however, positives that will help push up growth next year after a disastrous 2022, albeit well below the pre-pandemic pace of six-plus per cent and not enough to prevent a global economic downturn.
For investors, this means pinning hopes on a resurgence in Chinese demand — to offset economic weakness elsewhere — is misplaced. This has bearish implications for commodities and other cyclically sensitive assets, which have recently found support on hopes of a Chinese economic rebound.
With this in mind, we would use the recent period of strength to reduce cyclical exposure and raise cash to take advantage of better buying opportunities down the road. However, we do see a good opportunity here in long-dated high-quality bonds. Disappointing Chinese GDP growth will help ensure that deflationary pressures (which have been gaining momentum in recent months) will continue to build.
David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. The above column was written using research and contributions from the Rosenberg Research team. You can sign up for a free, one-month trial on Rosenberg’s website.