SUMMARY
There can be no doubt that China is in the midst of economic and ideological flux. Gone is the deferential ‘peaceful rise’ of old, replaced with the more assertive policies expected of an increasingly global military power. Gone too is the supply side-focused and debt-fueled model of economic growth – at least in theory – with Party officials now promising ‘common prosperity’ as a byword for a more equitable growth model based on domestic consumption and wealth redistribution. Yet numerous challenges loom in 2022 ,which together may slow or even reverse this supposed transition: global trade slowdowns, the omicron variant, the Winter Olympics, a reeling property sector, electricity production shortfalls, and an ever-growing debt balloon. Will Beijing succeed in staying the course?
BACKGROUND
A general economic slowdown
The Party’s top-level growth target, if kept at all, is expected to be in the vicinity of 5%, down from 6% in 2021. The tempered expectations reflect a near across-the-board decline in economic metrics to close out the year. Industrial production growth hovered in the 3.1-3.8% range from September-November, and retail sales have been equally soft, hitting just 3.9% year-on-year growth in November – a far cry from the 8-9% range that 2019 averaged. Overall, the Chinese economy grew 4.9% in the third quarter, and fourth quarter growth is expected to come in at around the same level.
Headwinds abound heading into 2022
China’s economic weakness of late can be traced back to several factors, namely COVID-related shutdowns, logistical bottlenecks and input inflation, energy production shortfalls, and a slowdown in the property sector.
Despite the public health benefits of its draconian containment measures to contain COVID-19, China has not completely escaped the negative impacts that have ravaged economies elsewhere. Moreover, given the policy divergence between China’s ‘zero Covid’ approach and growing insistence among other major economies to remain open amid soaring case rates, it stands to reason that these negative effects will likely worsen as China seeks to lock down clusters of omicron infection, especially in the lead-up to the Olympics. Furthermore, the efficacy of China-produced vaccines represents another potential wrinkle, as early clinical indications suggest that their ability to fight the omicron variant is significantly worse compared to mRNA peers. Thus, early hopes of the variant’s relative mildness notwithstanding, Beijing may be uniquely constrained with regard to omicron due to its population’s vaccine profile and relative lack of natural immunity owing to the absence of community spread (a victim of its own lockdown success in a sense). All this portends serious economic headwinds in the year ahead, particularly in the first few months.
Then there’s the litany of supply-side issues serving to thwart the efficacy of ‘the factory of the world.’ Prominent among them is the electricity supply shocks that rattled production in the northeast earlier in the year (subsequently alleviated by ramping up domestic coal production). Input costs have also been soaring, hitting 13.5% year-on-year growth rates in October before falling back slightly to 11.5% in November. Global shortages in shipping containers and port workers have also driven up shipping costs for many of China’s small- and medium-scale exporters.
A controlled deflation of China’s property bubble?
The saga of distressed property developer Evergrande dominated headlines in 2021; the effects of its collapse now loom large for 2022. The real estate sector is hugely important to the Chinese economy; it accounts for 25-30% of the GDP, with housing construction determining everything from the price of cement and steel to the fiscal well-being of China’s lumbering industrial SOEs. The real estate market also determines household wealth perceptions, which in turn influence consumption decisions. These perceptions have been severely negative to close out 2021, with the value of home sales dropping by approximately 16% in November – its fifth consecutive month of declines.
Evergrande – once China’s second-largest property developer – has now officially defaulted, and though the insolvency process remains somewhat unclear, it’s known that it will be guided by the opaque hand of the Party, and that all priority will be given to individual households who pre-paid for a yet-unfinished property. But the overriding question moving into 2022 remains: Who’s next? Evergrande’s debt woes are hardly unique, and several large developers have come under distress since the company’s crisis came to a head, most recently Shimao Groups Holding, which was generally considered one of the stronger players in the sector. Overall, S&P has warned that as many as a third of Chinese property developers will struggle to repay their debts in the year ahead.
FORECAST
The headwinds China faces in 2022 are clear and unambiguous, prompting a recent groundswell of the ‘stability’ mantra across any and all official policy statements. But the government response – and its potential effects – are much less so. Some stimulus measures have already been rolled out; for example, earlier this month the People’s Bank of China (PBOC) cut its benchmark lending rate by 5 basis points, injected some $188 billion of liquidity into the system by cutting banks’ capital reserve ratio, and increased targeted lending to small- and medium-sized businesses. There have also been hints from various ministries of more stimulus to come in the New Year. However, it remains to be seen whether or not President Xi is forced to roll back his two major policy thrusts of recent years: 1) moving away from the supply-side stimulus model of economic growth; and by extension 2) the imposition of restrictions on property lenders. Both initiatives are ultimately motivated by stability concerns, namely reducing the amount of debt in the financial system and thus precluding a potential liquidity crisis down the road. The Xi era has thus far had a light touch on sweeping stimulus plans, especially when compared to the type of stimulus that followed the Great Recession (and went far in creating China’s debt problems in the first place). More so than anything else, a sizable new stimulus package in 2022 could be taken as evidence that China’s leaders view the present economy as in serious distress, such that a short-term systemic risk can be swapped with a longer-term one.
