The COVID-19 Pandemic is a challenge for China, but there are still reasons for optimism May 5, 2022

The COVID-19 Pandemic is a challenge for China, but there are still reasons for optimism

Since late March 2022, China has been battling a wave of COVID-19 cases. On 10 April 2022, Shanghai reported its highest number of cases – with 914 patients showing symptoms and 25,173 asymptomatic1.

China’s sudden surge of COVID-19 cases is only a small part of the problems the country is grappling with. The authorities are responding, with many economists viewing the current problems as temporary.

Derek Scissors, Chief Economist at research firm China Beige Book, said that China’s economy is not in serious trouble. Richard Yetsenga of ANZ, said that while the Chinese economy faces “pretty serious headwinds” in the current quarter, however, with the way the situation is being handled, the economy should return to good health.

Chinese officials also expect the country to recover quickly from its current troubles.

Li Baodong, Secretary General of Boao Forum for Asia (BFA), said at the recent BFA Annual Conference 2022, that China’s economy will recover faster than the global average along with other Asian economies despite the new outbreak of COVID-19 cases, commodity price hikes and Russia-Ukraine crisis.

Among other issues, China is also grappling with inflation, with the impact immediately visible on the markets.


Impact on share prices

China and Hong Kong SAR stocks hit a low on 11 April 2022: The CSI 300 index, which tracks the largest mainland-listed stocks, fell 3.09% to 4,100.07, while the SSE Composite Index, which tracks Shanghai listed stocks fell 2.61% to about 3,167.13. Similarly, Hong Kong SAR’s Hang Seng index closed 3.03% lower at 21,208.30 and the Shenzhen component dropped 3.671% to 11,520.212.

One of the main reasons for these falls was concern about inflation numbers. China’s consumer inflation rose higher than expected in March as the consumer price index was up 1.5% YoY. In tandem with that, China’s producer inflation rose 8.3% as compared to the same period in the previous year.

Commenting on the China stock markets performance, Ramiz Chelat, a Portfolio Manager at Vontobel Asset Management, told CNBC on 11 April 2022: “I think the more notable fact is the big gap between Consumer Price Index and Producer Price Index, and that indicates that pricing power amongst most companies in China is weak and they’re taking a hit on margins.”

Chelat added that localised lockdowns would be a recurring theme considering the infectiousness of the COVID-19 Omicron variant and said that in this scenario, investors should be selective in China, and to look for companies that can deliver in a growth-challenged environment3.

Meanwhile, Chinese economic data has been mixed. Numbers released on 18 April 2022 showed that as first-quarter gross domestic product accelerated, retail sales decreased in March for the first time since 2020, indicating that the COVID-19 lockdowns of the previous weeks were possibly having an impact.

The authorities are reacting and Al Jazeera reported on 15 April 2022 that officials cut the reserve requirement ratio, but avoided lowering interest rates as a cautious approach to policy easing.

For now, China’s COVID-19 restrictions are disrupting supply chains and adding to global inflation. Inflation itself has been amplified by disruptions to commodity flows owing to the Russia-Ukraine war and Russia’s isolation. Furthermore, there are also concerns that the Fed is shifting to a more aggressive policy tightening to contain the cost of living which would leave the US economy in a decline.

Globally, stocks and US equity futures dropped on 18 April 2022, treasury yields increased and a surge in energy costs showed that inflation is impacting market sentiment and the global economy. Japanese and Chinese shares fell along with Nasdaq 100 contracts and S&P 500, treasuries also dropped on the possibility of Federal Reserve monetary tightening, which extended the 10 year yield to about 2.86%4.


Commodity cost pressures

Commodity cost pressures have heightened in China as the Russia-Ukraine war strained supply chains and created production obstacles. The rise in material costs is also hurting economies globally and analysts wonder how much China’s central bank can ease monetary policies as China’s consumer prices and factory-gate prices surge.

Nomura analysts said that there will be possible delays in crop planting due to COVID-19 outbreaks in China, along with the Russia-Ukraine war, could lead to new food price pressures in the latter part of the year.

Nomura analysts said on 11 April 2022: “Rising food and energy price inflation limits the space for the (People’s Bank of China) to cut interest rates, despite the rapidly worsening economy.” They also urge Investors to keep a watch on oil and gas prices, which are rising5.

China’s manufacturing and service sectors have also reported a decline in activity due to the local COVID-19 flare-ups. Authorities have tried to ease the situation with greater fiscal spending and a reduction in the income tax of small firms.

As for consumer prices in China, they are rising, but inflation has remained relatively moderate, seemingly because of the weak consumption due to Beijing’s strict COVID-19 control regulations.

Commenting on the implications of China’s current Covid-19 outbreak on the economy, chief economist for Greater China at ING, Iris Pang, said that Shanghai’s economy could shrink 6% in April 2022 alone, taking into account that the lockdown persists, which would lead to a 2% gross domestic product decline throughout China.

As for how China could tackle inflation, Sheana Yue, China Economist at Capital Economics, said that despite the price of some goods remaining high in the near term, she believes that wider inflation will be contained and that PBOC will decrease borrowing costs and reduce reserve requirements for banks or lower interest rates for more cash to be circulated into the economy6.


Looking ahead

Investors banking on an upturn in the Chinese economy can find some solace in the fact that although China’s economy is struggling for now, some economists said that it will soon recover.

Derek Scissors, Chief Economist at research firm China Beige Book, said on 20 April 2022: “We’re not looking at outright contraction as China suffered in 2020,” Scissors told CNBC’s Squawk Box Asia7.

Richard Yetsenga of ANZ said that Chinese officials have held talks on policy support for the economy. This is reflected in PBOC’s announcement on 18 April 2022 of its intentions for financial support for industries, businesses and people affected by the outbreak8.

China on 20 April, maintained its benchmark lending rate with the one-year loan prime rate remaining at 3.7% and the five-year loan prime rate at 4.6%.

Despite China’s efforts, economists at Bank of America remain sceptical and have reduced their forecast for China’s 2022 GDP growth to 4.2% – initially set at 4.8%. This is a vast difference from Beijing’s GDP growth target of 5.5% for 2022.

The reason for their doubts is attributed to the current lockdowns that are widely spread across the country, bringing about many faults in logistics. Businesses are being affected in the long term due to the unwillingness of consumers to shift to online platforms, along with the unwillingness for the relocation of supply chains which would benefit other countries once they start to reopen9.


Further assistance

On 22 April 2022, Yi Gang, China’s central bank chief pledged that PBOC would maintain an accommodative policy to support a damaging period for the economy by helping small firms and sectors affected by the COVID-19 outbreaks. Furthermore, the governor also reiterated the need to maintain price stability despite the pressure of high inflation10.

His comments come as an increasing number of analysts cut their China growth forecasts because of extended lockdowns in major cities that have affected highways and ports, shut factories and stranded workers.

Yi Gang said that the PBOC will ensure price stability and focus on grain output and energy supply to ensure that China’s inflation will be sustainable in 2022.


Deposit rates reduced for China’s megabanks

On the banking front, some of China’s major state-owned banks reduced the rates on some deposits of consumers on 25 April 2022. Among them were China Construction Bank, Agricultural Bank of China, Industrial & Commercial Bank of China and Bank of Communications which slashed 2-year, 3-year and 5-year rates on certificates of deposits and other types by 10 basis points. After the cut in rates, the 2-year certificate of deposit rate is now at 2.6%11.

Also, China’s officials have pressured banks to lower the premiums offered to savers over the benchmark deposit rate by 10 basis points across all tenors. Although it is not compulsory, lenders who oblige to the request will receive boosted scores when PBOC conducts its quarterly macroprudential assessment.

It is also important to note that the PBOC avoided cutting rates on 1-year policy loans that it extends to commercial banks which would have allowed banks to charge less for loans, essentially helping families and small businesses while maintaining the banks’ margins.

So, despite the Chinese authorities’ efforts to support its economy, their latest actions may further impair Chinese households that have already been dealt with underperforming stock markets, real estate and depleting wealth.


Faster Recovery for Chinese Economy

According to a report published during the Boao Forum for Asia on Asia’s economic prospects, Asia’s proportion of global economic output increased to 47.4% in 2021, recovering at a pace much faster than other regions amid the global pandemic for the past year12.

Separately, the Director of Institute of World Economics and Politics, Professor Zhang Yuyan, mentioned during the conference that Asia’s economic growth is expected to exceed IMF expectations set at 4.8%13.

Therefore, while acknowledging the challenges China faces in the short-run, economists and the authorities feel the current problems can be overcome.

Whatever your view of the current crisis, if you are seeking exposure to the China market, one way to do this is through ETFs.


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