Residents queue for a Covid-19 test in Shanghai on July 10. Shanghai’s Covid-19 cases continue to rise, prompting authorities to declare more high-risk areas and sparking fears that China’s financial hub might tighten movement restrictions again. Photo: Bloomberg
by Nicholas Spiro
by Nicholas Spiro

Will China’s ‘zero-Covid’ policy thwart its plan for infrastructure-fuelled stimulus?

  • While the US central bank aggressively tightens monetary policy, China is going back to its old playbook of stimulus via public investment
  • However, the tensions between Beijing’s public health policies and its shifting economic priorities are a key impediment to effective stimulus
There are plenty of uncertainties in the global economy and markets. In the past few months, one of the biggest questions facing investors is whether China’s more aggressive stimulus programme can mitigate the damage caused by the government’s uncompromising “ dynamic zero-Covid” policy, which has resulted in a stop-start economy.
The fact that China’s stimulus package is a major talking point in markets is itself a testament to the dramatic shift in economic policy since the start of this year. In 2021, Beijing’s deleveraging campaign and regulatory clampdown stood in sharp contrast to the explosive stimulus-fuelled rallies in advanced economies. While the benchmark S&P 500 equity index soared nearly 27 per cent, the blue-chip CSI 300 gauge fell about 5 per cent.
This year, the US Federal Reserve has embarked on a rapid tightening of monetary policy to rein in high inflation. President Xi Jinping, by contrast, has instructed the government to make an all-out effort to boost infrastructure investment in response to the severe economic disruptions caused by China’s draconian controls to stamp out Covid-19.
As the Fed implements the biggest increases in interest rates in decades, clobbering global bond and equity markets, Beijing is resorting to its old playbook of boosting growth through public investment. Since the 2008 financial crisis, infrastructure and property were the main sources of the credit-fuelled excesses that the deleveraging drive had sought to tame.
In a sign of the extent to which China has been forced to shift to looser policy, local governments – a crucial funding conduit for infrastructure projects – sold a record 1.9 trillion yuan (US$288.5 billion) of bonds last month, topping the previous all-time high of 1.3 trillion yuan in May 2020.
What is more, to speed up infrastructure investment, the government is considering fast-tracking the issuance quota for local government special purpose bonds that fund infrastructure schemes, freeing up a further 1.5 trillion yuan for investments in the second half of this year.

China announces US$44.7 billion for infrastructure projects to boost economy

Credit growth is already rebounding sharply. Aggregate financing – a broad measure of the flow of credit in the economy – surged to 5.2 trillion yuan last month. That is the highest amount for the month of June, according to data from the People’s Bank of China dating back to 2017.

Investors, many of whom have become more upbeat about China in recent months, see the stimulus programme as a critical factor underpinning a recovery, along with the end of the brutal lockdown of Shanghai and mass testing aimed at averting further citywide shutdowns.

Battered commodity markets, which are sensitive to the outlook for the world’s second-largest economy given that it accounts for large amounts of annual demand for many raw materials, showed signs of stabilising last week. In a report published on July 8, JPMorgan said an acceleration in bond issuance “would underpin our confidence in China’s infrastructure-driven demand recovery” in the second half of this year.

Yet, there is ample reason to be sceptical about the efficacy of more forceful stimulus. For starters, the underlying problem – the acute difficulty in keeping the highly infectious Omicron variant at bay without imposing further citywide lockdowns – continues to hamper policymakers’ ability to stimulate the real economy.


Tens of millions under lockdown in China following outbreak of Covid BA.5 subvariant

Tens of millions under lockdown in China following outbreak of Covid BA.5 subvariant

Infection rates in China are ticking up again. According to Nomura, 31 cities accounting for 25.5 per cent of economic output were implementing full or partial lockdowns as of July 11, up from 11 cities constituting 14.9 per cent of output the previous week.

Rolling lockdowns, and the increasing fear of them, are ruinous to the effectiveness and credibility of stimulus. Moreover, local governments are under severe financial strain and being forced to divert resources away from key services and priorities, including infrastructure, towards funding mass testing.
Second, China’s property sector, which has been the main vehicle for deploying stimulus, is in crisis. Many homebuyers are refusing to pay mortgages because of persistent delays in completions of homes, while stresses in the nation’s US dollar-denominated property debt market are spreading to the most creditworthy developers.

Where are the white knights in China’s US$1.7 trillion property sector?

Third, the infrastructure investments that China plans are in the new economy and are much less commodity-intensive than previous projects, which included airports and high-speed railways.

This partly explains the muted response in markets. A Bloomberg index of industrial metals has dropped a further 23 per cent since early June. Copper, traditionally seen as a barometer of economic activity, is down a further 11 per cent this month.

To be sure, the sell-off in commodities reflects broader worries about a global recession. Even if investors were more confident about the reopening of China’s economy, they have to contend with inflation-fixated central banks in developed economies that seem determined to crush inflation come what may.

Yet, it is the sharp tensions between China’s public health policies and its shifting economic priorities that are the main impediment to effective stimulus. That Beijing appears willing to allow these tensions to persist indefinitely is particularly concerning.

Nicholas Spiro is a partner at Lauressa Advisory