China’s zero-Covid policy was based on an unsustainable economic model and yet the announcement to reopen came as a surprise to the world. Even more unexpected was its very rapid – if not immediate – implementation.
It should have been clear when the Omicron variant reached China in January 2022 that Covid-19 could, and would, spread despite a zero-Covid policy. The irony of this, however, is that China’s leadership decided to maintain its stance for as long as eleven months afterwards. Even during the 20th Party Congress in October last year, no sign was given that zero-Covid policies would be lifted.
The effects of these policies converged in various ways. Tight mobility restrictions contributed to a reduction in consumption, reducing GDP growth by as much as 2.5 percent in 2022. As a result, the actual growth rate of China ended up only being 3 percent last year. If mobility restrictions had not been implemented, GDP growth could have been as high as the official target of 5.5 percent.
A recovery in consumption has occurred since mobility restrictions were lifted at a national level in December. Pre-Covid-19 levels have since been nearly restored, demonstrated by inter-city travel rising quicker than intra-city mobility in the run up to the Chinese New Year.
Trends for long-term growth, however, reveal a structurally weakening economic environment. Two other important policy measures in this respect include a further tightening of real estate restrictions and a crackdown on the tech and the general private sector. Combined, the tightening caused a collapse in property investment and while China’s reopening will certainly throw a lifeline to both sectors, this is not the main reason why the outlook for both sectors has improved, at least in the short term.
Rather, the increasingly poor economic situation since the beginning of the trade war, along with the Covid-19 crisis, has made it essential for the leadership to re-start the economy. Given the poor state of local government finances, the collapse of many small and medium-sized enterprises (SMEs), stagnant household income (and high household savings), and growing youth unemployment, this is a non-negotiable objective.
China’s growth trajectory is certainly heading back to a path of growth. This is not the only reason why the reopening has occurred at lightening speed. Indeed, the government is lifting regulatory restrictions on real estate developers, including reversing the destructive “three red lines” policy designed to limit leverage, and much of the pressure on the tech sector. Both sectors are bound to be better placed in 2023 than last year given the importance of growth on the political agenda.
Growth, therefore, is likely to hover around 5.5 percent in 2023, which is slightly above the latest International Monetary Fund projection in the Spring World Economic Outlook (forecasted at 5.2 percent), but still less than some sell-side analysts suggest. The bulk of China’s growth should come from the recovery of consumption, followed by some recovery in investment as general sentiment improves. External demand should contribute less to China’s growth in 2023 given the rather stagnant economic growth in the US and Europe (though this is already much better than originally expected).
Challenges beyond 2023
While it does seem that there will be less pressure on the private sector in 2023 (in order to boost household income), the government is unlikely to implement a permanent 180-degree turn on policies designed to rein in the private sector. As long as the Xi Jinping-led regime remains convinced of the superiority of China’s economic model – which is tightly linked to the political model – there will not be a structural change – in terms of a larger role for the private sector. This has become increasingly clear in the run up to the Two Sessions meetings which are currently taking place. Because of this clear direction, we should not be expecting anything but a slow and steady deceleration of the Chinese economy, particularly as declining demographics, labor productivity, and the piling up of debt increasingly add to the challenges the government faces. Innovation is the buzzword to mitigate these trends, but the increasing presence of the state in the economy will clearly not help maintain a healthy and dynamic private sector.
The recent decisions to ease restrictions for the private sector, including real estate developers and tech companies, should be viewed as ephemeral, reflecting a pragmatic approach to a difficult situation. In other words, Chinese leaders desperately need growth to be reset as a way to maintain the status quo after years of quite extreme economic difficulties. Once this tactical objective is achieved, the leadership will be expecting both the real estate and the tech sectors to contribute to the China dream by supporting common prosperity. Furthermore, tech entrepreneurs, the core of the private sector, will probably need to continue to be monitored to ensure they remain aligned with the party’s strategy and objectives.
Even if political tensions remain high, 2023 should be a rather good year for China’s growth outlook, at least when compared to what is expected down the line. 2023 will be cyclically good but, structurally, China’s growth will continue to decelerate. The explanation for this much more positive path for 2023 is simple: it’s because of the large and positive base effect after a terrible 2022. The opposite will be true in 2024 where the base effect will be negative, curving out growth up to 4.5 percent and structurally for the next few years to around 2.5 percent by 2030.
China’s leadership will need to deliver growth to improve the currently difficult economic conditions of local governments, SMEs, and households. This will be easy in 2023, but much harder in future as there is hardly anyway for the government to stop China’s rapid structural deceleration.
Alicia García Herrero is the Chief Economist for Asia Pacific at Natixis. She also serves as Senior Fellow at European think-tank BRUEGEL and non-resident Research Fellow at National University of Singapore’s think tank, East Asia Institute. She is currently an Adjunct Professor at the Hong Kong University of Science and Technology. Finally, Alicia is a member of the Advisory Committee for Economic Affairs of the Spanish Government as well as an advisor to the Hong Kong Monetary Authority’s research arm (HKIMR).
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