China’s economy is creaking under the weight of its zero COVID policy

Last year’s crackdown on developer influence cut off developers‘ access to finance and left huge numbers of apartments unfinished and, because Chinese developers operated on a pre-sale model, dozens of thousands of very angry home buyers who paid for homes that were not completed.

There are protests in the streets and, increasingly, rising levels of mortgage defaults and bank loan losses as these buyers refuse to repay loans for properties they cannot live in. This will add to the existing intense pressure on developers and on a sector that has historically contributed more than 30% to Chinese growth.

PBOC Governor Yi Gang said the economy was facing “some downward pressure” due to the pandemic and external factors and would act to provide stronger economic support.Credit:Bloomberg

The recovery towards the end of the June quarter was helped by the reopening of Shanghai, which had experienced closures in April and May. Shanghai’s economy contracted 13.7% in the quarter.

This highlights how vulnerable the economy as a whole is to COVID outbreaks. New cases are still being reported in Shanghai, and new outbreaks and lockdowns are occurring in Henan and Guandong provinces. National numbers of daily infections are at nearly two-month highs.

While authorities have slightly relaxed their approach to COVID, Xi Jinping has made it clear that trying to keep outbreaks under control is his top priority, even if it impacts economic growth. That tension could grow as Xi’s ambitions for an unprecedented third term as national leader reach their moment of truth at the Communist Party’s national congress later this year.

The external environment is not favorable to China. The strongest aspect of its economy has been the recovery of its exports, but high inflation rates and tighter financial conditions are slowing global economic growth and threatening a global recession.

The zero-COVID policy has impacted national economic activity and, after last year’s sudden crackdown in the real estate and tech sectors that left investors with significant losses, triggered a substantial outflow of foreign capital.

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These funds are flowing into emerging markets and the safe haven US Treasury bond market where rising yields (following the Federal Reserve’s response to inflation surging to 40-year highs and strengthening of the US dollar) have made US bonds a more attractive investment option.

So far, authorities have refrained from the kind of massive stimulus programs launched by China in response to the 2008 global financial crisis.

There have been some small but targeted investments in infrastructure, but concerns about the degree of leverage within the economy, particularly at the local government level, have disciplined the response to the current downturn.

This may change. Beijing has increased the number of bonds local governments can issue this year and has urged local authorities to issue most new “special” bonds by the middle of the year. Central authorities are said to be considering authorizing a new wave of bond sales – several hundred billion dollars in new debt – for the second half of the year.

Last year's crackdown on property developer leverage cut off developers' access to finance and left huge numbers of apartments unfinished.

Last year’s crackdown on property developer leverage cut off developers’ access to finance and left huge numbers of apartments unfinished.Credit:Getty Images

Already heavily indebted local governments have been hit hard by implosions in the real estate sector – land sales generate much of their revenue – and the initial bond sales were meant to help them stabilize and recapitalize smaller banks in their regions so that they can increase their lending while the new tranches currently being considered would finance another round of infrastructure investment.

The People’s Bank of China has taken a relatively conservative approach to monetary policy and is not coping with the inflationary pressures faced by other major central banks (which is an indication of the weak economy).

Over the weekend, however, the PBOC, quoting its Governor Yi Gang, said the economy was facing “some downward pressure” due to the pandemic and external factors and would act to provide stronger economic support.

The external environment is not favorable to China. The strongest aspect of its economy has been the recovery of its exports, but high inflation rates and tighter financial conditions are slowing global economic growth and threatening a global recession.

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A greater reliance on a national economy that is experiencing a property sector crisis that is sending ripples of distress through the Chinese financial system; which is opening and closing in response to COVID cases and which is seeing outflows of foreign capital at rates not seen for many years almost dictates that China will have to open the fiscal and monetary policy taps if it is to generate a growth rate with a four ahead of it this year, not to mention the 5.5% target the authorities have named and still adhere to.

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