Chinese domestic activity data of late have consistently underperformed even our very low expectations, actualising the downside economic risks we had flagged earlier from a rushed reopening and the stickiness of weak consumer sentiment in China.
With the dismantling of most COVID-controls in recent weeks, authorities in China have effectively accepted that the economic benefits of reopening outweigh the costs of an immediate health crisis. But a normalisation in economic activity will take some time, requiring among other things, a change in public perceptions towards contracting COVID and vaccine effectiveness.
Exhibit 1: With a faster reopening, we see near-term economic disruptions, but a more substantive rebound in the quarters ahead
Revising our forecasts to incorporate a darker winter, with risks skewed to the downside
In response to the recent sharp underperformance of domestic activity, we have downgraded our near-term growth forecasts, including an anaemic 2% y/y growth pace in the first quarter of 2023. Our weaker outlook reflects the economic consequences of a surge in caseloads and fatalities, along with the uncertainty over policymakers’ reaction function in the face of rising fatality rates, all of which keep consumer confidence at bay.
All of this will also take place against a backdrop of weaker external demand, in view of an impending global recession and a slowing manufacturing cycle in Asia.
The Chinese consumer now has to climb out of a deeper trough
The government recently signalled that it intends to focus on domestic consumption growth in 2023. We think this reflects the anaemic pace of growth in 2022 in private consumption (1% by our estimates) and the role household spending plays in the authorities’ “common prosperity” mandate. For 2023, we expect private consumption to rebound, albeit at a still-below trend pace of 6.6%.
While private consumption has traditionally borne the brunt of a COVID-driven slowdown in growth, any subsequent recovery will very likely be asymmetric.
The Hubei and Shanghai lockdown experiences in the first quarter of 2020 and second quarter of 2022 respectively, suggest that personal consumption expenditures in China took around two to three quarters to recover to pre-lockdown levels once restrictions were lifted. The situation is in some ways more challenging now, given that Chinese consumers are climbing from a deeper trough, even if they are benefiting—for the first time—from a more definitive policy pivot towards reopening.
There are a few reasons why we’re less optimistic about a quick or meaningful rebound in Chinese consumer spending.
First, the pullback in retail spending has been increasingly broad-based, suggesting that it will take time to reverse the negative psychological impact on Chinese consumers brought on by three years of episodic lockdowns. The harsh realities of a rushed reopening could exacerbate consumer sentiment fragilities. The first quarter of 2020 and second quarter of 2022 lockdowns drove a disproportionate drop in demand in high-value discretionary items, but more recently we have also seen cheaper discretionary items impacted similarly (Exhibit 2).
Exhibit 2: Consumers have pulled back spending on discretionary items, even low-value ones
Second, a speedy recovery is also being hampered by shifts in household liquidity positions over the course of the pandemic. Unlike the outright cash payoff schemes seen in Hong Kong and Singapore that go some way in supporting household spending, China’s COVID-relief programmes have instead focused predominantly on supporting businesses affected by lockdowns. Using available financial institutions’ credit funds data, we estimate that while households saved on average 3.5ppts more of their disposable income through the pandemic, an increasing amount has been channelled to relatively illiquid assets or savings accounts that effectively lock up cash in the near term (Exhibit 3). Deteriorating labour market conditions, seen in higher-trending unemployment rates, as well as the potentially negative wealth effects associated with a property sector slump, are undermining households’ confidence about future earnings (Exhibit 4).
Exhibit 3: COVID-era excess savings may not translate into a release of pent-up demand
Exhibit 4: Consumer confidence has plunged through 2022 and stands at a record low
Constrained policy easing on the cards
After a year in which the government has resorted to one-off fiscal buffers and leveraged more off-budget channels, we expect narrower fiscal headroom in 2023. Indeed, the local government funding gap has now widened to the highest level since monthly records began in 2008. Heading into 2023, the maturity profile of local government debt will also peak, potentially constraining the fiscal flexibility authorities need to offset more meaningful near-term economic disruptions and drive growth.
Still, with overall macro leverage remaining somewhat manageable (general government debt was 49.7% of GDP in the third quarter of 2022, still benign notwithstanding the 11.2ppts climb through the course of the pandemic), accommodative fiscal policy settings will likely stay the course.
The authorities will inevitably have to rely on infrastructure spending to keep domestic demand afloat. We anticipate the general government budget deficit narrowing to 8% for 2023, from 8.6% in 2022, with stimulus to be front-loaded earlier in the year in anticipation of a weaker macro environment.
Exhibit 5: Ample liquidity, but credit demand falls by the wayside
Likewise, monetary policy will remain loose, but we note that loose monetary conditions have not translated into meaningful credit growth (Exhibit 5), reflecting an impaired monetary transmission mechanism in the face of a weak property sector and the slump in consumer confidence.
As broad demand-side conditions improve heading into the latter quarters of 2023, we expect this transmission mechanism to strengthen. But policymakers will have to do much more just to achieve the same desired outcome.
Slow-healing scars from episodic lockdowns and outbreaks
China’s COVID-management practices over the past three years effectively shaved off 4.7% of its GDP (in level terms) in terms of foregone economic activity. Furthermore, productive spending, such as households’ spending on education, culture and recreation, has also fallen meaningfully, particularly across urban households, where spending on such items is almost 13% below trend.
China’s labour markets are also more strained. New urban employment—the number of gross new jobs created in urban areas—is still 10% below its pre-COVID level. This is a larger fall than implied by most indicators of economic activity we track for China. Despite this, the surveyed urban unemployment rate only increased moderately (+0.5ppts in November 2022 vs December 2019), suggesting that a significant number of urban workers who lost jobs during the pandemic left the urban labour force.
More severe economic disruptions associated with a rushed reopening will exacerbate these stresses, and our analysis of post-pandemic experiences elsewhere suggests that the hit to labour supply may take time to correct. The adverse longer-term “scarring” impact of these shifts on both economic output and employment are well-documented (see IMF 2022, OECD 2021, World Bank 2021, to name a few).
All of this means that despite the favourable low-base effects of 2022, 2023 will prove to be a challenging year as policymakers navigate multiple cyclical and structural headwinds. In fact, in the absence of meaningful structural reforms, our projections further out do not see China close its output gap until 2030.
Louise Loo is a senior economist at Oxford Economics. She covers macroeconomic research and forecasting on Greater China’s economy. Prior to joining Oxford Economics, she was a senior economist at Morgan Stanley and Goldman Sachs. At Goldman Sachs, she was also an advisor to China MoF with regards to its sovereign credit rating.