China’s Road to Reopening

The Chinese government has quickly changed course. After months of enforcing a zero-COVID-19 program that stymied growth, China has dramatically loosened restrictions on its population. In my view, the recent wave of COVID-related protests, driven by an elevated youth unemployment rate of 18%,[i] played a critical role in accelerating the government’s timetable. I believe China would have eased up on restrictions eventually, but the students’ activism convinced the government that the economic and political costs of the lockdowns had become intolerable.

As the second-largest economy in the world, China’s reopening has important economic and market implications, both in the country and beyond. Here are some key considerations.

A disorderly but potentially remarkable recovery  

In the short run, I believe China’s economy is likely to experience chaos rather than progress for a simple reason: China is poorly prepared to deal with COVID. Prior to lifting the zero-COVID policy, more than 90% of the Chinese population had not been infected with the virus.[ii] Though vaccination rates are high, rates among the elderly are lower than the overall population, and there are few intensive care unit beds relative to the size of the population. China’s ICU capacity is around 10% of what is available in the US.[iii] On top of all that, China relies on a vaccine that is less effective than the mRNA vaccines commonly used in the rest of the world.[iv]

In the initial phase, I believe the reopening may unleash a wave of COVID cases that could overwhelm the health care system, dampening consumption and production in the process. Policymakers aren’t likely to enforce widespread lockdowns, but factory production may experience some supply disruption. It would not surprise me to see growth rates as low as zero over the next three months, down from the current pace of around 2% year over year.

After the first few months, I think the story will improve as the health crisis eases. The government is already taking measures to speed that outcome by stepping up its campaign to boost vaccination rates for those over 60. I expect Chinese growth to recover by the second quarter of 2023 and top 5% in the second half of the year. Growth may get additional help from the anticipated loosening of restrictive housing policies, which have also been a drag on China’s economy for the past 18 months.

A broadly positive impact on Asian markets

Because markets generally look forward, market pricing will probably move ahead of the real economy as investors look beyond the short-term chaos and anticipate better days ahead. I expect Chinese equities and corporate bonds to be beneficiaries, and volatility could provide potential buying opportunities.

An uptick in Chinese growth would also provide a boost to growth in other Asian countries, particularly if Chinese tourists resume their normal travel patterns. Nearby Asian countries, such as Thailand, Vietnam and Japan, could see strengthening currencies as a result.

An inflationary wild card

In my view, China’s reopening is a wild card for inflation. For the past year, as inflation rose sharply in the US and Europe, China acted as a disinflationary counterweight. Amid sluggish growth, the country used fewer commodities and less energy than normal. To cite just one example, China’s demand for oil has been running 1 million barrels a day below trend.[v] China’s appetite for commodities and energy is likely to climb as its economy recovers, driving up prices just as the inflation in the rest of the world is expected to ease.

Will Chinese demand be strong enough to change the global inflation outlook and affect the rate-setting policies of central banks? It is too soon to say, but it is something to keep an eye on as 2023 unfolds.

[i] National Bureau of Statistics of China, as of October 2022.

[ii] https://ourworldindata.org/covid-cases, as of 14 December 2022.

[iii] https://worldpopulationreview.com/country-rankings/icu-beds-per-capita-by-country, as of 14 December 2022.

[iv] https://www.ncbi.nlm.nih.gov/pmc/articles/PMC9047219/pdf/ciac288.pdf

[v] Loomis Sayles estimate, as of 14 December 2022.

MALR030172