With so much in flux with China’s Covid dynamics, this note lays out a few reflections on the current state of play.
A joke circulating on Chinese media this week captures the whiplash from Covid policies that many of us – especially those living through it in China – are feeling:
The public: When are we going to open up?
Beijing: Ten
The public: Ten months? Ten weeks?
Beijing: Nine, Eight, Seven…
While China is still far from a true “reopening,” the joke reflects the fact that zero-Covid ended sooner than we expected, the leadership planned, and the country had fully prepared for. Three key factors came together in November to accelerate the timing:
- Zero-Covid was increasingly failing in limiting outbreaks, meaning ever harsher measures would be necessary to sustain the policy
- Economic pressures from containment measures were mounting, including fears over supply chains and local government fiscal collapse
- Social discontent boiled over, resulting in the broadest public protests in China since 1989
Where are things now? Our note earlier this week noted that this is a period of suspense: the government, population and public health system are entering a new phase of “living with Covid,” but are only just now beginning to feel the stress of surging cases (please see: Macro outlook depends critically on how Beijing handles the coming Covid surge, 7 December 2022).
Here is our quick summary of the overall situation:
- At the central government level, zero-Covid is officially over but the exit plan is unclear. Messaging has shifted in just a few weeks from playing up the necessity of containment to stressing that Omicron is mild enough to justify a shift in policies. A key uncertainty is the leadership’s tolerance level for a surge in cases and especially deaths.
- At the local government level, major cities such as Guangzhou and Beijing have loosened testing and quarantine policies in recent weeks even as cases surged. This trend will spread after the central government’s latest measures released this week (discussed in earlier note), which give clearer directions to other cities to follow this lead. Still, for many people in China, especially outside the largest cities, the perceptible changes have thus far been slight. While there is more personal freedom thanks to reduced testing and lockdowns, other restrictions – such as closures of public venues, work-from-home requirements, and school closures – remain in place.
- Infections are likely growing but at an unknown rate. The reduction of PCR testing in the last two weeks means that official data, which show a recent decline in cases, are an inaccurate guide to the growth of outbreaks. Anecdotal evidence and the trend in infections throughout November would strongly suggest that cases are climbing quickly, but for now we are all somewhat flying blind.
- Public health preparations are belatedly ramping up. Having focused attention and resources in the last year on containment rather than preparing for a pivot, the government is now moving to address key weaknesses in the public health system – the vaccination campaign and hospital capacity. On vaccination, the government has set a goal of ensuring by end-January that 90% of the population above 80 has received at least one dose of a vaccine. Daily vaccinations are now starting to ramp up (see chart below), but it likely won’t be until spring (at least) that a high proportion of this population receives booster doses (the current level is roughly 40%), which is necessary for strong protection. There continue to be broader uncertainties as to the effectiveness of China’s inactivated vaccines, particularly how long protection lasts after a booster shot. On hospital capacity, local governments are constructing quarantine hospitals for completion in the spring and ramping up ICU facilities. Still, this is likely to remain a vulnerability, especially in poorer provinces, given not only resource constraints but especially a shortage of trained personnel.
- The population is starting to adjust to the reality of catching Covid. As cases rise and local governments reduce testing and quarantines, households have started to adjust – including by voluntary reducing their own movement, resulting in mobility in large cities reaching a level last seen during Shanghai’s lockdown in April. Coming months will see the economy increasingly hit by voluntary restrictions, not just containment measures, especially in a rapid pivot scenario. There are reports of runs on some medical supplies such as fever medication and oxygen, though little to suggest major panic.
What’s next
There will obviously be a great deal to follow in coming days/weeks, particularly if/when a surge hits. Among the key watchpoints for us in terms of China’s policy response are:
- The severity of cases, which thus far has thankfully been low
- The tolerance for severe cases and deaths at the local and central government level
These will be important factors for how the pivot proceeds: as discussed earlier this week, we currently see a rapid pivot scenario and gradual pivot scenario as equally likely (40% probability). If severe cases remain low, or the government adopts a fairly high tolerance for them, it will strengthen momentum behind a rapid pivot scenario. If severe cases and fatalities threaten to rise sharply, then a gradual pivot is more likely. We also hold out a 20% probability of an especially chaotic scenario, in which a rapid pivot goes first goes smoothly but then threatens to become a public health disaster, leading to a partial re-tightening of measures and volatile policy.
A rapid pivot scenario will be disruptive at first but better for a recovery in Chinese demand in 2023. A more gradual pivot is somewhat less disruptive but leads to a more subdued recovery given the weight of continued containment measures throughout the year.
Sizing up the outlook for growth and stimulus
Bloomberg reports, citing sources, that China’s Central Economic Work Conference will take place on 15 December, though this is not fully confirmed. The Politburo meeting earlier this week provided relatively few clues as the CEWC’s content (we will hold a webinar to review the CEWC’s key takeaways).
Clearly the overall tone will focus on supporting growth and confidence, but a key question will be indications of how much Beijing will bank on the pivot to drive the recovery versus more forceful stimulus. That balance may not become fully clear until the National People’s Congress in March, given how much is in flux.
The muted market reaction to China’s latest Covid loosening measures suggests investors have moved beyond the initial “reopening trade” and are now starting to focus more on the uncertainties ahead – in particular, for deflationary pressures as the economy takes a hit from the surge, particularly as household risk aversion rises. (Yesterday’s report from 22V’s portfolio strategy team discusses this in the broader global market context).
Such concerns over growth are warranted, not only because of the bumpy road ahead but also the fact that China’s government is unlikely to provide the kind of direct fiscal support to households that helped sustain domestic demand in the West during the rockiest periods of the pandemic. China’s stimulus in the last three years (and long before) has focused on credit support for firms and investment projects, helping the production side of the economy but leading to restrained demand, especially consumption. This orientation is likely to continue, which means that a recovery of consumption and broader demand next year will depend to a large degree on how orderly the pivot is and how long it lasts.
While the above points to deflationary pressures from China as it enters the pivot, there are some risks of supply chain disruptions, particularly in a rapid pivot scenario. Long citywide lockdowns are unlikely – there is no going back to those now that zero-Covid is over – but workers will get sick, and some logistics/transport could be challenged if cities need to impose harsh social distancing measures to prevent hospitals from being overwhelmed.
We will be closely covering Covid dynamics as well as macro policies in the days ahead, but please reach out to discuss at any point.
