Several large cities in China saw significant protests over zero-Covid and related grievances this weekend. Local protest is not unusual in China, but it is extremely rare to see simultaneous demonstrations across multiple cities, linking diverse groups such as university students and everyday citizens. This is precisely the kind of episode that the Chinese Communist Party views as a major threat and has been largely effective in preventing. It demonstrates that the population’s tolerance for Covid restrictions is nearing – and may have already reached – a boiling point.
Given that dynamics around social protests and outbreaks are both highly fluid, it is wise to be humble about making predictions about what happens next. However, here we lay out some provisional thoughts, with more updates to come. We will hold a Webinar on China’s Covid policies and the outlook for the economy on Tuesday at 11am ET (please register here).
Our key point for now is that investors who conclude that: (1) protests will lead China to loosen Covid restrictions in the near-term; and (2) that this would bring relief to the economy, are likely being overly optimistic on one or both counts.
Zero-Covid is the basecase, but rising risks of a chaotic pivot
In our report on Wednesday, we laid out three Covid scenarios for the winter: persevering with zero-Covid with modest changes (60% probability); a chaotic pivot this winter (25% probability); and a relatively smooth “controlled pivot” this winter (15% probability). (Please see: Reality check on a Covid pivot is still sinking in, 23 November 2022).
The main implication of current protests is to increase the probability of a chaotic pivot from 25% to 35%. Maintaining zero-Covid remains the basecase but the probability declines to 55% (from 60%) while the probability of a “controlled pivot” scenario falls from 15% to 10%.
Unless protests grow significantly larger – which is a very real possibility – we do not think China’s leadership will view them as enough of a dire threat to abandon the zero-Covid framework. While the recent protests are a serious warning to the Party, they thus far remain relatively small in size and could potentially peter out. For Xi Jinping, reacting to demonstrations by significantly loosening Covid restrictions would pose two dangers. First, given that China’s public health infrastructure and vaccination campaign are not ready for a major reopening, a loosening could unleash a surge in serious illness and death that hurts the economy, panics the population, and renders his three-year campaign against Covid a failure. Second, giving in to demonstrations risks legitimizing such protests, which Xi is loath to do given his emphasis on the Party’s complete monopolization of power.
We expect Beijing’s response in coming days to be as follows:
- Hope that protests soon wane, while gradually stepping up coercive measures against demonstrators
- Place the blame for Covid missteps on local officials and announce actions such as firings and investigations
- Reiterate that local governments should avoid excessive Covid restrictions, while emphasizing that China must adhere to zero-Covid given the public health risks (this was the message of a People’s Daily article over the weekend)
This strategy will do little to change the underlying frustration over Covid policies. But the leadership will likely try to persevere at least until the lunar new year holiday (starts 22 January) as China battles its worst Covid outbreak to date.
However, the possibility of a chaotic pivot scenario this winter is rising as the population, as well as local governments, are clearly reaching exhaustion in maintaining zero-Covid policies. If protests continue to grow, or if the population becomes less compliant with Covid restrictions, local officials may conclude that the political risk of maintaining harsh restrictions outweighs the risks of letting outbreaks spread. The leadership may be forced to accept this outcome, at least in some localities, in the face of local exhaustion and Omicron’s high transmissibility.
A chaotic pivot is likely to be highly disruptive to the economy – quite possibly worse than zero-Covid, at least in the near term. We define a chaotic pivot as Chinese authorities essentially abandoning – by choice or by force – the hope of preventing a surge in cases through testing and lockdowns. But this does not mean that China “lies flat”: local governments will need to maintain tight restrictions in areas at risk of seeing the hospital system overwhelmed. Moreover, a chaotic pivot scenario would also damage the economy through increased voluntary restrictions on behavior from households worried about infection. Simply put, while a chaotic pivot could potentially shorten the timeline for China’s eventual reopening, the overall economic and social risks would be high.
The probability that China executes a “controlled pivot” this winter that progressively reduces containment restrictions while minimizing fatalities is low and falling. This outcome would require a decisive and orderly transition in China’s public health strategy and messaging campaign. The current dysfunction and inertia in China’s Covid policies, particularly problems with center-local coordination, indicate this is unlikely. Another key challenge is the very poor financial condition of local governments, which limits their ability to expand ICU capacity and handle a flood of cases.
Finally, we have noted that China’s overall outlook in coming months will likely be a blend of these three scenarios. Most provinces are likely to try to maintain zero Covid, but a chaotic pivot in at least some cities is increasingly likely. Only cities with very high bureaucratic and financial capacity, such as Shanghai, will be able to execute a smooth controlled pivot.
Near-term watchpoints:
In coming days we will be watching:
- Dynamics around popular discontent, including geographic spread of protests as well as intensity
- Responses by local government officials. Are they passively allowing protests to spread or cracking down?
- Messaging from China’s leadership, including the degree of emphasis on adherence to zero-Covid, or signs of grudging acceptance in further loosening
- Covid outbreaks. The largest outbreak, in Guangzhou, shows signs of slowing. But the national situation is tenuous and Beijing’s outbreak continues to grow
