China: warm spring, hot summer, explosive fall?

As in the rest of the world, difficulties first arose from the environment and climate change. As well as huge fires triggered by drought and periods of extreme heat along the Yangtze River (the “Blue River” that runs across the country from west to east), there has also been lethal flooding in Qinghai (in the northwest) and, now, an earthquake in Sichuan (in the east), whose capital Chengdu (population: 21 million) is currently under a drastic lockdown. With the rice harvest approaching and lockdowns putting pressure on supply chains, the threat to crops is very real.

Summer has brought an end to China’s zero-Covid strategy: far from it. As the 20th National Congress of the Chinese Communist Party – which kicks off on 16 October and is set to see Xi Jinping re-elected for a third term as both party leader and president – draws near, the tendency is, if anything, towards constant and greater vigilance. Beyond Chengdu, 65 million people are currently under strict lockdown – a number that could increase as the Congress approaches, especially if new cases are detected around Beijing. 

Zero-Covid all the way

“When will it end?”, people ask in the West. Apparently, neither the 0.4% growth seen in the second quarter – the second poorest performance after Q1 2020, at the height of the first wave of Covid – nor projections of sub-3% growth in 2022 (compared with an annual target of 5.5%) are liable to call into question this public health strategy, which some in Beijing fear could continue at least until Lianghui (plenary sessions of parliament) in March, during which all the changes pertaining to Xi’s new mandate will be ratified.

While China’s healthcare system would undoubtedly not be able to cope with an uncontrolled flood of new cases, the damage to the country’s economy is becoming broader and deeper with each passing quarter, mainly caused by the distortions of an increasingly unbalanced model.

The Chinese economy’s three scars

First is youth unemployment, which came in at 19.9% in July: a ticking time bomb for a regime whose social contract is founded on the promise of improved living conditions for each generation of (only) children. 

The second and clearly visible scar is that left by regional distortions in growth. China’s regions had previously been growing at a similar rate to the country as a whole; Covid has introduced sharp disparities. Cities – especially those placed under the strictest lockdowns or public health restrictions (Beijing, Shenzhen and, above all, Shanghai) – have suffered more than the rest of the country. 

Hit hard by restrictions on services and travel, cities suffered more than the countrywide average in 2020. However, during the recovery phase (2021), base effects aside, growth was buoyed by consumers with greater purchasing power and more savings. But repeated lockdowns and deteriorating youth unemployment are increasingly dragging down economic performance. 

While public health measures have had less of a direct impact in more rural provinces and secondary cities, that’s not to say those areas are without their problems. The main problem is, of course, the property crisis, which is hitting such areas particularly hard. Both surface areas sold (down 27% year on year) and housing starts (down 36%) have continued their precipitous decline over the summer, depriving local councils of a significant income stream (up to 50% of total income). 

The crisis has worsened as grass-roots movements have emerged encouraging people to refuse to make their monthly payments. With only 60% of homes pre-sold between 2013 and 2020 delivered, more and more residential construction sites have ground to a halt as dozens of developers have gone bust. 

Over and above the risks to the banking system, if this trend were to spread, it would call into question an entire growth model: after a crisis of confidence on this scale, it should not be taken for granted that consumers will agree to pay in advance for homes with no guaranteed delivery date. But this model lies at the heart of China’s property sector, which had become a huge Ponzi scheme in which developers used prepaid funds not to build the homes for which they had been deposited but to repay their debts or buy up more land. In having failed to guarantee a protective legal framework for consumers, the government is not without fault. Whether it will stand as lender of last resort is another matter, so eye-wateringly huge are the amounts in question.

The third scar lies in contributions to growth. The imbalances in the model, pointed out towards the end of the first wave of Covid in April 2020, persist. In the second quarter, unusually, contributions to annualised growth from net exports, investment and consumption were just about identical at 0.9, 0.8 and 0.8 percentage points respectively. While the country’s trade deficit breaks new records each month – it has nearly doubled since 2020 and stands at over $850 billion over 12 months – consumer spending has still not recovered. Retail sales were still down 4.6% in the last quarter, while the service sector grew at a paltry 1.8%.

And how have the authorities responded? With more monetary easing, which will undoubtedly have no impact on consumer behaviour.

Exports fell short of expectations in August, up 7.1% year on year (compared with 18% in July), whereas they had been expected to grow by around 13%. But this is no surprise in light of industrial production, which has slowed sharply (up 0.6% over the last quarter), or PMIs, which have moved back into contractionary territory. This is something to keep a close eye on: a downturn in external demand would deprive China of a second growth driver.

For the second time in three years, China has abandoned its annual growth target. The symbolic weight of this decision – especially during the crucial run-up to the National Congress – cannot be denied. Beyond the symbolic, though, it is China’s ability to continue as a managed economy, and to successfully pursue its economic policy and control its growth trajectory, that is in question. Yet this ability to plan and manage the economy is at the heart of China’s growth model. Against this backdrop, it’s not at all surprising to see the government tightening its grip on the private sector: control is exercised where there is still scope to do so (within businesses via increased Party presence, through pressure and penalties on the tech sector, etc.). One question remains, however: what will the strategy be after the Congress? Will the government revert to a more flexible approach to controlling the economy and public health? Or will the world have to contend with a more closed-off, more statist but economically weaker China – a China that might be tempted to seek out new sources of power beyond its borders, starting with the South China Sea?

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