SINGAPORE (May 29): As Europe and the rest of the world reopens for business after their lock-downs, governments and economists are studying the Chinese model. China was a FIFO — First In, First Out — case for Covid-19.
“In China… draconian measures were enacted, such as absolute lock-downs. The nationwide shutdown exerted a clear shock to the economy – recording a negative 6.8% y-o-y growth rate in the first quarter of 2020 – but that has also positioned China for a strong recovery going forward,” notes UBS Asset Management.
It is not so simple. China has many issues to juggle, including possibly a US-China cold war, US President Trump’s temper tantrums and Hong Kong.
In a recent briefing, Aidan Yao, senior Emerging Asia economist at AXA Investment Managers, describes China’s experience with Covid-19 in three phases. The first phase was the lockdown. This caused a sudden stop to economic activity during the Lunar New Year period and the ensuing weeks. “When the economy came to a sudden stop, house sales and coal consumption fell to near zero,” Yao indicates.
Both Wuhan and Hubei province were in total lockdown till April, although other parts of China started opening up gradually by mid-February. Unlike Europe and the US, where people continued to mingle during their lockdown phases, China had a much more draconian lockdown, which was able to halt the spread of Covid-19 in the country, including Hubei province.
The gradual opening of China and “supply normalisation” is what Yao describes as the second phase. “As conditions outside of Hubei province improved and this allowed the provinces to gradually relax controls, we entered Phase 2 with factories pressing the restart button,” Yao says.
In Chart 1, supply normalisation is represented by coal consumption as factories restart production. Pent-up demand led to a sharp rebound in property purchases.
The impact on the Chinese economy during Phases 1 and 2 were significant. In 4Q2019, the Chinese economy expanded by 6%, and in 1Q2020 it contracted by 6.8%, translating into a 13 percentage point decline which was more severe than either the Asian Financial Crisis or the Global Financial Crisis.
“Part of the GDP loss was because of the severity of the virus and Beijing’s more aggressive and draconian controls. There is a negative correlation between GDP and the strictness of the lockdowns,” Yao says. Globally, China had the most aggressive lockdown compared to the other countries.
The new normal
During Phase 2, manufacturing re-covered faster than the consumer sector. Consumers are obviously concerned about wages and unemployment. Large companies normalised faster than SMEs, and supply normalised faster than demand.
“Supply normalisation is a defining [characteristic] of this phase, and the US and EU could experience this too,” Yao cautions.
Phase 3 comprises demand normalisation. This is a lot more tricky. Chart 1 shows that this has been quite flat. “For Phase 3 we did not have a huge rebound because of demand. There are two reasons why demand is not coming back. One is external. The global economy is teetering on the edge of a recession that could rival the great depression. Second, internally, unemployment has jumped,” Yao indicates.
Concerns in the labour market over unemployment, a decline in wage growth, worries over job cuts and the correlation with consumer spending has curbed consumption demand which is an important component of domestic demand.
The Chinese economy’s value-added (i.e., value of inputs by every enterprise in the economy to intermediate goods) is about 14% of GDP, and a y-o-y decline in export growth of 18% would translate into 3.2% drop in GDP (see Chart 2). That is the first driver of external demand. The slower consumption recovery is a negative 2%. Yao has imputed policy support at 5.5%, and pent-up demand at 2.3%. The net figure would be a negative 4% as represented in Chart 2.
How can GDP rebound?
“To get a faster recovery, we need external help and that’s where pol-icy plays a role,” Yao says. During the recent National People’s Congress (NPC) meeting, no GDP growth target was set for this year, given huge domestic and external uncertainties. In addition, the new job creation target was also lowered by 2 million to 9 million. The budget deficit was lifted from last year’s 2.8% to 3.6%, keeping the fiscal deficit within 3% of GDP for the first time in 11 years. The consumer price inflation (CPI) target was lifted to 3.5% from 3% in previous years, potentially giving more room for monetary policy easing ahead.
While Beijing was the earliest government to provide a growth impulse, it lagged behind in the quan-tum of support — for instance, the US stimulus is already more than 20% of GDP, and economists reckon it will rise to 50% of GDP when Covid-19 is done and dusted.
Why is China’s stimulus so meagre? “When China was suffering from supply constraints, stimulating the economy would have been of no help. Secondly, the fiscal stimulus needs to be approved by the NPC. Now both these constraints have been removed and we’ve seen a multitude of stimulus measures,” Yao says. The major ones that have been announced and implemented are likely to provide 4.2% of GDP support.
New infrastructure, urbanisation
The stimulus measures focus on new infrastructure. The Government Work Report (GWR) lists new infrastructure as a key element of “effective investment” to support domestic demand. According to China’s National Development and Reform Commission (NDRC), new infrastructure includes:
• information infrastructure (e.g., 5G, Internet of Things [IoT] and industrial internet; AI, cloud computing, blockchain; data centres, intelligent computing centres)
• integrated infrastructure (e.g., smart transportation, smart energy infrastructure and smart cities)
• innovation infrastructure (e.g., scientific & technological infra and industrial innovation facility).
Broadly, it could include other non-traditional facilities needed for better growth quality like public health facilities, care centres, electric vehicle charging stations and UHV (ultra-high voltage electricity) grids. New infrastructure is expected to be the foundation for China’s technological and structural upgrade.
“The new infrastructure that has been talked about includes 5G stations, IoT, electric vehicles, starter grids, and so on. All this infrastructure is needed to allow the economy to take off in the next phase of economic development and continue technological convergence with the US. This kind of infrastructure is going to generate more productivity and efficiency. It will be less wasteful and will generate better quality GDP,” Yao explains.
On the flip side, the US has ratcheted up its anti-China campaign, blaming China for Covid-19 and demanding reparations. It has also banned supplies from US companies to Huawei. Other risks to the Chinese economy is a rebound in Covid-19 cases. In Northeast China, a mini-outbreak emerged and this region is under a mini-lockdown.
In addition to new infrastructure, the GWR pledged to drive new urbanisation. China’s hukou-based urbanisation ratio was 44.4% last year, much lower than its residency-based measure at 60.6%. The gap was around 227 million migrants living and working in cities without an urban hukou. Their becoming urban citizens would support property demand and help unleash a new round of demand for autos, home appliances and other durables as well as services, Citi Research suggests.
While the details of fiscal stimulus have yet to be released, fiscal stimulus is usually a lot more targeted than monetary stimulus. “Fiscal policy is more targeted and micro-sector driven, and also the Chinese government's debt to GDP is actually very low, at 17% of GDP. Hence, the Chinese government has a lot of capacity to leverage up,” Yao says.
He expects the Chinese economy to rebound in 2H2020 (see Chart 3) and record positive GDP growth of 2.3% this year. “We are computing flat GDP growth in Q2, 5% growth in Q3 and 9% in Q4 to give a full-year forecast of 2.3%, and I don’t think it’s out of line with Beijing’s calculation,” Yao says.
