Light at the end of the tunnel after a weak Q4

China’s economy had a turbulent year in 2022. Consumers and businesses suffered gloomy prospects in an erratic regulatory environment, amid disruptive zero-Covid constraints. The anti-lockdown protests that erupted in November partly reflected frustration at the economic impact of Covid controls on people’s daily lives. As Xi Jinping’s third term in power began, key policies crumbled under shockingly direct criticism from protestors. However, the sudden reversal of China’s stringent Covid policies is a long-awaited game changer for the economic outlook, though it came too late to improve 2022’s growth.

China’s economy expanded by 3 percent in 2022, the weakest growth since 1976. Following another slowdown to 2.9 percent growth in Q4, there is hope that the growth trough has finally bottomed out. Naturally, there are high hopes for a quick recovery as the economy begins to reopen fully and economic growth returns to the top of the leadership’s list of priorities.

Before China’s economy moves on to the post-pandemic phase there will be several waves of Covid infections. China’s health care system will likely be put to the test and companies will need to deal with spikes in sick days. But there is finally light on the end of the tunnel. As the economy begins to normalize, the services sector and consumption can start to recover. The process will need effective policy support.

The Central Economic Work Conference confirmed that there will be more stimulus measures this year, in the form of monetary easing and increased fiscal spending. Boosting consumption and private sector investment are key priorities. It has been reported that authorities are considering special local government bonds of up to CNY 3.8 trillion in 2023 – a new record. Increased spending will push the budget deficit to around 3 percent, up from 2.8 percent in 2022. In China, this is a stronger signal than the numbers might suggest, as a lot a public spending is conducted off-the-book. However, the overall stimulus will be constrained by debt control and the need to manage financial risks for local governments that are already highly leveraged.

Aside from stimulus measures and scrapping zero-Covid, China’s economic policies underwent other remarkable reversals in Q4. Crackdowns on the tech and real estate sector were eased, marking a course correction from the seemingly uncoordinated policy blitz over the past two years that damaged economic sentiment and cut growth. The greater centralization of economic policies under Xi looks to have failed its first real test, though economic leaders may be learning from mistakes and making adjustments.

Amid a looming global recession, China’s policymakers enter 2023 adjusting their economic policies to domestic pressures and growing external challenges, a theme that is likely to continue. Despite growing optimism, China’s recovery remains vulnerable, especially as it has become more difficult for policymakers to engineer growth. How the government responds to the new challenges will be a good indication of whether and how Xi’s economic policy priorities will shift – if at all. The last quarter has clearly given an indication that his policies seem to be contested.

Macroeconomics: Zero-Covid leaves its mark on GDP growth one last time

• China’s economy had a volatile year as multiple, localized Covid lockdowns undermined growth, alongside regulatory crackdowns on tech firms and the crucial real estate sector. In Q4, GDP growth slowed to 2.9 percent, the third lowest quarterly growth on record. Annual growth fell to 3 precent, the second lowest rate since 1976. The painful economic costs of the zero-Covid policy were a major reason why it was abandoned in early December.
• The service sector remained hard hit by the government’s economic policies, making a sustainable recovery impossible. The stagnant services sector dragged down overall GDP growth. Growth in services fell to 2.3 percent in Q4, down from 3.2 percent in Q3. The slowdown was driven by the sharp contraction in real estate, and the impact of zero-Covid policies on transportation and hospitality (see exhibit 2).