Outlook 2022: China – Striking a finer balance between growth and sustainability
- A confluence of shocks which plagued the economy this year will continue to exert influence in 2022-23
- Macro policy that has exacerbated the pain will be recalibrated to better support growth next year
- The biggest risk to the anticipated recovery stems from Beijing's failure to strike a delicate balance
Post-pandemic rebound fails to impress
2021 has been an unusual year for the Chinese economy. As it recovered from the most catastrophic shock in modern history, annual growth rates in the first half of the year appeared buoyant but simply reflected favourable base effects. As the year progressed, the economy was battered by a series of natural and man-made shocks. Resurgences of COVID-19, severe flooding, a cooling housing market, soaring commodity prices and a severe power shortage all took their toll on the post-pandemic rebound that was already losing steam due to lacklustre domestic demand. A series of punitive regulatory actions added to the economic woes and posed a setback for financial markets (Exhibit 1). Hence, rather than a triumphal return to trend growth, the economy weakened for a second time.
Exhibit 1: Unusually tight policy adds to growth pains
Source: CEIC and AXA IM Research, 9 November 2021
Looking ahead to 2022, the Chinese economy will likely be buffeted by many of the same factors – albeit not necessarily in the same direction. Lying at the core of our forecast is the assumption that the worst of the policy tightening is over, and that Beijing has started to recalibrate policies to foster growth stability. We explain the rationale of this policy shift and its likely efficacy in counteracting prevailing headwinds.
Three forces shape the outlook
We categorise the three major drivers of the economy next year as transitory, persistent, and uncertain. In the transitory camp lies the adverse weather effect, which has already diminished, and the impact of power shortages. The latter contributed to the sharp growth slowdown in Q3-2021 by disrupting industrial activity with power rationing and blackouts that affected many in the worst-hit regions. Thankfully, the authorities responded in a swift and forceful manner. A concerted effort to raise coal production for thermal power generation, widening the electricity price band, and a forceful crackdown on coal speculation all helped alleviate the shortage. High-frequency data shows that major power plants have started to rebuild coal inventory after coal price collapsed and supply increased. Household electricity usage also normalised with the government pledging a stable power supply for the winter. Even though the most energy-intensive users – including steel, cement, and aluminium producers – may still face lingering power rationing, the bulk of the economy should see its power demand met, limiting the impact of the transitory shock beyond end-2021.
In contrast to the short-lived power crunch, the housing market correction is set to exert persistent pressure on the economy next year. In retrospect, the introduction of the “three red lines” may have marked a turning point in Beijing’s attitude towards the sector under “housing is for living, not speculation”. Its perseverance to continue the market curbs despite rapidly falling activity and growing financial stress suggests that this time is different from the typical ‘run-of-the-mill’ property crackdowns in the past.
Underscoring this attitude shift is likely a recognition that the current housing development model – characterised as reckless and debt-fuelled – has become increasingly incompatible with many of China’s long-term strategic goals. As an amplifier of wealth inequality, the growing housing bubble is a major impediment to common prosperity. Housing construction, along with its upstream industrial sector, are the two biggest emitters of greenhouse gases, making them a target for the decarbonisation push. Finally, housing is an unproductive asset that produces no output and employment after completion. This contrasts with building a factory which creates jobs and productivity thereafter. Hence a reallocation of resources away from housing to other productive sectors should prove beneficial for the whole economy.
We think the recent regulatory tightening, combined with the fast tracking of a nationwide property tax, confirms that such a change is underway. However, reallocating resources from a sector, which accounts for a quarter of the economy and 70% of household wealth, necessitates careful planning and execution. In light of rising economic risks, the authorities have started to fine-tune policies to ensure that the pursuit of long-term objectives does not imperil short-term stability. This is no policy U-turn, but more a “two steps forward and one step back” approach to balancing objectives across horizons. We expect real estate policies to become incrementally less punitive to help stabilise, not revive, the market next year. The risk is that Beijing fails to strike such a fine balance, resulting in further suffering for the economy.
Finally, the outlook for exports and the pandemic remains highly uncertain. As one of few bright spots in the economy, China’s exports have benefitted from a strong demand recovery in developed markets (DM) and still fractured supply in emerging markets (EM) due to lingering COVID-19. The outlook for next year is clouded by the evolution of external demand, which may weaken somewhat as DM growth softens. China may also relinquish some export market share as EM production resumes, although the sharp increase in foreign direct investment since 2020 suggests that Chinese exporters may have regained a lot of competitiveness. Finally, there are encouraging signs from recent US-China trade talks, which could lead to tariff exemptions that in turn bolster Chinese exports to the US. Overall, we expect export growth to fall from the astronomical 20% plus rate this year to a more normal, but still solid, high single-digit to low-teens rate.
The uncertainty around COVID-19 remains the biggest domestic risk. This is not limited to how the virus will evolve by itself and in relation to vaccines, but also how China’s virus-fighting strategy will change as more countries adopt a “learning to live with it” approach. Periodic lockdowns against even a small flare-up of infections have come at great cost to the economy, inhibiting consumption and services recoveries (Exhibit 2). The more frequently such restrictions are imposed, the greater the risk that the domestic recovery is permanently impaired.
Exhibit 2: “Zero-COVID” strategy comes at a cost
Source: CEIC and AXA IM Research, 9 November 2021
However, despite the apparent costs of the “zero-COVID” strategy, we do not expect Beijing to change it any time soon for social and political reasons. Recent experiences of countries moving towards living with the virus have all resulted in a sharp surge in local infections. While that may be necessary to achieve collective immunity, such a cost could prove grave for a Chinese population living effectively COVID-19-free since mid-2020. Any drastic policy shifts that reignite public fears of the pandemic could be seen a colossal mistake by the government. We, therefore, think that Beijing will be very careful about deviating from the status quo unless further major medical breakthroughs against COVID-19 are achieved. This implies downside risks for our consumption forecast, which assumes a steady recovery to trend growth.
Policy turns the corner, followed by growth
To balance the three groups of economic shocks, Beijing’s policies will prove critical. Contrary to the stated stance at the beginning of the year, the actual operation of countercyclical, regulatory, and deleveraging policies has been much tighter in 2021. We think Beijing’s surprisingly high pain threshold reflects its recognition that the structural developments which China is undergoing – including the pursuit of common prosperity and higher quality growth – will inevitably create short-term pains. Those pains are better faced through a strong, cyclical economic rebound from a low base. 2021 thus offered a rare opportunity to pursue these reforms despite their known side effects.
However, the macro environment has changed significantly from a year ago and that demands an urgent rethink of policies for 2022. With growth slowing sharply and base effects turning unfavourable, Beijing cannot afford to continue with current policies that risk driving the economy into a hard landing. We therefore expect a wholesale recalibration of macro policies next year, which could consist of 1) more lenient regulatory policies, 2) more accommodative monetary policies – focusing on targeted liquidity injections and credit growth stabilisation – alongside 3) greater frontloading of fiscal stimulus.
With the waning of transitory shocks, these policy changes should help to put a floor under the economy. As growth momentum gradually recovers from a cyclical trough in Q4 2021, we expect full-year growth to be at 5% for 2022 before rising gently to 5.3% in 2023. The risks around our forecast are large and biased to the downside. Besides those already discussed, conditions in the labour market bear close watching for signs of genuine weakness in consumption. We also continue to monitor commodity prices as persistent cost pressure can erode corporate profits that inhibit business investment and limit monetary policy easing.