Why China is likely to recover more slowly from the recent Covid shock

As Shanghai tries to reopen businesses, a downtown district banned residents from leaving their apartment complexes for mass virus testing over the weekend. Here in another district on May 21, 2022, a line can be seen in front of a shopping mall.

Xu Kaikia | Visual China Group | Getty Images

BEIJING – China’s economy will not recover quickly after the recent Covid outbreak, many economists are predicting.

Instead, they expect a slow recovery.

When the pandemic first broke out in 2020, China recovered from a first-quarter decline to grow in the second quarter. This year, the country faces a far more transmissible strain of the virus, overall weaker growth and less government stimulus.

The latest Covid outbreak, which began in March, has hit metropolitan Shanghai hardest. About a week ago, the city announced plans to come out of lockdown — and fully reopen by mid-June.

“For China, the main story here is that we saw the light at the end of the tunnel. The worst of China’s supply chain disruptions from the Covid lockdown appear to be over,” said Robin Xing, Morgan Stanley’s chief China economist, during a webinar on Friday.

“But we also believe the road to recovery will likely be slow and bumpy,” Xing said.

It’s a process of fits and starts. Over the weekend, a district in downtown Shanghai again banned residents from leaving their apartment complexes to conduct mass virus tests. More and more parts of the capital, Beijing, ordered people to work from home as the number of daily cases locally rose – reaching 83 on Sunday, the highest for the city’s recent outbreak.

Case in point: German automaker Volkswagen, which has factories in two of the hardest-hit regions this year, said on Wednesday its manufacturing plants in China were operational but Covid controls were disrupting supply chains.

The automaker said it was unable to give an exact figure on production levels because the factories are joint ventures operated with local partners.

Although the number of national Covid cases has declined over the past month, new cases from Beijing to southwest China have prompted bans on houses and mass testing. Freight volume remains below normal.

“Many regions and cities have tightened restrictions at the first sign of local cases,” Meng Lei, China equity strategist at UBS Securities, said in a statement last week.

“Our case studies from Shanghai, Jilin, Xi’an and Beijing show that logistics and supply chain disruptions are the biggest pain points affecting the resumption of production,” Meng said. “As such, the return to work is likely to be gradual rather than overnight.”

A Cycle of Policy Making ‘Breaked’

The Chinese government has maintained its strict “dynamic zero Covid” policy despite this year’s emergence of the highly transmissible Omicron variant.

The “most significant impact” of the Covid resurgence is that it “disrupted” the normal timeline of policy-making, said Dan Wang, chief economist at Hang Seng Bank China in Shanghai.

She said the latest spate of cases and lockdowns really only started after the central government released its annual economic plan at the “Two Sessions” parliamentary session in March.

In China’s heavily managed economy, this annual gathering is a crucial part of a cycle to develop and implement national policies – across departments and regions.

The supply chain disruption and lackluster consumption are manageable, but once the political timeline is disrupted, “it is difficult to get it back on track quickly,” Wang said.

There are so many different economic goals that “many trade-offs have to be made between different ones [government] departments,” she said. “That made the political process extremely slow and limping.”

The information office of China’s State Council, the country’s top executive body, did not immediately respond to a CNBC request for comment.

This year, before the regular reorganization of the heads of state and government planned for the fall, politics will have particular weight with officials. Chinese President Xi Jinping is expected to remain in office for an unprecedented third term.

Half as much stimulus as in 2020

At the beginning of March, Beijing set targets such as GDP growth of “around 5.5 percent” at the “two sessions”. But that’s about 1 percentage point or more above the forecast of many investment banks – which have repeatedly lowered their growth estimates for China as Covid lockdowns continue.

Wang is sticking to a relatively high forecast of 5.1% as she expects China to ramp up stimulus and ease tight Covid controls later in the summer.

But so far, nearly two months after Shanghai went into serious lockdown, policymakers have yet to make major changes.

Whether in terms of interest rates or fiscal policy, the level of government stimulus is still about half what it was at the peak of the pandemic in 2020, Morgan Stanley’s Xing said.

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With the exception of unemployment, most economic indicators have not reached worse levels than at the beginning of 2020.

Among other measures, the central government has announced tax and fee cuts for small businesses and has started to lower mortgage rates. But the impact, particularly on the massive real estate sector, may take time.

Xing noted that even without Covid, an easing of guidelines in the real estate market would take three to six months to impact homebuying activity.

Other parts of China are humming along

However, it’s also possible that growth in China will come faster than many expect.

“The silver lining is that the experience of the past two years suggests that a Covid-induced recession tends to end quickly, especially with swift and forceful policy responses,” said Larry Hu, chief China economist at Macquarie, last week in a note.

Work continues for much of China, even as there are additional virus testing requirements.

About 80% of production in southern China is back to normal. Although the region’s major city, Shenzhen, closed almost all shops for about a week in March, transporting products by truck within a province is “okay”. Due to the very low number of Covid cases in the region, Klaus Zenkel, chairman of the South China chapter of the EU Chamber of Commerce in China, told CNBC on Friday.

Members in southern Guangdong Province — a manufacturing hub — “are all busy, they all have work to do,” Zenkel said. He noted that companies were keeping their inventories fuller than before to avoid an ongoing shortage problem.

But “unpredictability is there,” he said. “You don’t know what’s going to happen.”

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