As winter comes early to China’s economy, Beijing must focus on short-term growth

Beijing shouldn’t rush to achieve long-term goals – such as reaching net zero carbon emissions and deflating the housing bubble – when the economy is in free fall
Rather, it should rethink its zero-Covid, property and coal policies before the risks to growth worsen

Aidan Yao

Published: 2:30pm, 6 Oct 2021

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While mid-autumn should still bring plenty of warm sunlight, winter appears to have descended early on the Chinese economy. A combination of renewed virus outbreaks, a cooling housing market and spreading power shortages is weighing on the economy that was already struggling under macro policy normalisation.

Even with buoyant exports – the only engine of the economy still functioning properly – a double dip in growth now looks likely in the third quarter.

Investors are holding out hope of a growth rebound in the fourth quarter. But with economic headwinds stiffening and the authorities reluctant to act aggressively, the risk of a hard landing has risen. Beijing urgently needs to recalibrate its cyclical and structural policies to keep systematic risks at bay.

There are currently three key risks plaguing the economy.

The first is the uncertain outlook for the pandemic-hit economy. Even though China’s fight against Covid-19 is hard to fault from a public health standpoint, there are high economic costs associated with its zero-tolerance strategy, when compared with countries that have chosen to live with the virus.

The on-off social restrictions required to contain even a small flare-up of infections have created significant uncertainty for consumers and businesses, and therefore economic volatility.

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With over 2.19 billion shots in arms, China has fully vaccinated 78 per cent of its population

A Delta wave that started in late July – triggering the most stringent mobility controls since early 2020 – was the main culprit for the sharp consumption slowdown in August.

Even though most of these restrictions have since been removed, a recent Covid-19 outbreak in Fujian could still hinder the recovery. It might be time for Beijing to re-evaluate its Covid-19 strategy as the disease becomes endemic.

Another major headwind for the economy is the rapidly cooling housing market. Since the introduction of the “three red lines” policy and other related credit tightening measures, the housing market has been a drag on growth.

Sharp falls in home sales and construction starts have slowed the market, while the tight credit supply has spoiled developers’ appetite for land. This has, in turn, weakened the fiscal position of local governments, as shrinking revenue from land sales affects their ability to push for infrastructure investment.

Evergrande debt crisis could force China’s hand on reforming government

Not surprisingly, some property developers with weak balance sheets and limited funding channels have fallen victim to the restrictive policies. What is unexpected is how far the problems have spread so that even a behemoth like Evergrande is now on the brink of collapse.

Although I don’t think the Evergrande crisis is China’s “Lehman moment” – not least because of Beijing’s extensive control over a financial system that is still reasonably isolated from the rest of the world – one cannot deny that a poorly managed debt restructuring of the world’s most indebted property developer can still send shock waves across the economy.

Given how high the stakes are, it’s reasonable to believe the government will be involved, in some capacity, in the final resolution to the crisis. Perhaps there will be some relaxation of real estate policies, to ring-fence troubled assets and keep contagion risks at manageable levels.

The final and most recent addition to China’s economic woes is power shortages across the country. Some 20 provinces have placed restrictions on power usage, affecting economic activity in key manufacturing hubs such as Guangdong, Jiangsu and Zhejiang.

A confluence of factors has contributed to this. On the supply side, the clampdown on the coal industry in recent years has forced many small mines to close, creating a tight supply of coal that was exacerbated by weak imports this year.

In addition, skyrocketing coal prices have dramatically raised the cost of thermal power generation – a cost that electricity firms cannot easily pass on to end users as power prices in China are controlled by the government. This has created disincentives for electricity firms to meet rising power demand from manufacturing firms trying to fill strong export orders.

This imbalance between supply and demand has also collided with Beijing’s drive to reduce energy consumption to honour its decarbonisation pledge. Under the pressure of energy quotas, some local governments have rationed electricity, affecting economic activity and the daily lives of millions in the worst-hit regions.

The aforementioned three factors contribute to formidable headwinds for the Chinese economy. Without an urgent recalibration of policies – either paring back tightening measures or offering more cyclical support – the risks of a slowdown might spiral out of control.

It makes no sense for Beijing to rush, campaign-style, to achieve long-term objectives – such as reaching net zero carbon emissions or deflating the housing bubble – when the economy is in free fall. Instead, priority should be given to preserving short-term growth and creating a stable macro environment to allow incremental reforms to transform the economy in a steady and orderly fashion.

Aidan Yao is senior emerging Asia economist at AXA Investment Managers

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