The risks to our forecasts would mainly come from Covid-related uncertainties, especially domestic restrictions, the magnitude of the property downturn and the scale of policy support. In the case of longer-lasting tight Covid-19 restrictions or a deeper property downturn, GDP growth in 2022 could drop to 4%. Meanwhile, any upside, either from stronger exports or faster relaxation of Covid policy, will be limited, as China would limit macro policy support in that case. The events below are not our baseline forecasts but possible surprises:
The biggest uncertainty is still the Covid-19 pandemic and related restrictions. Contrary to our baseline, China’s Covid-19 restrictions may stay as tight as now for longer or even tighten further, either due to the spread of the new variants or a more cautious government stance than expected. In which case, more cities may experience lockdowns, inter-regional and inter-city travel may be widely restricted, and offline activities may be suspended for longer. This would lead to weaker labor market and consumption recovery, and possibly some disruption in production or ports, though overall impact on China’s supply chain should be limited. On the upside, though less likely in our view, a full coverage of booster shots combined with highly effective anti-Covid drugs and/or a sharp decline of Covid-19 infections would likely lead to faster and broader easing of Covid-19 restrictions, prompting a stronger consumption recovery.
The property downturn may be sharper than expected due to insufficient or ineffective policy easing. With property activities in deep contraction and market confidence low, the government’s policy easing may be too modest and too slow, especially in significantly improving developer cash flows. In addition, property market sentiment may weaken further as home prices fall, leading to an ineffective response in the housing market to the government’s policy easing. Property sales and new starts may decline by 15-20% and real estate investment could decline by 10%, adding another 1-1.5 percentage points drag to GDP growth and worsening financial system asset quality significantly.
Policy support may be less than expected and infrastructure investment may disappoint again in 2022. While both the Politburo meeting and Central Economic Work Conference have called for policy support to stabilize economic growth in 2022, policy actions have been limited and modest so far. Government agencies and local governments may have other policy priorities or be constrained elsewhere, including by the local government debt limit, and policy support may fall short of expectation. With limited additional explicit fiscal funding and continued tight controls on local government financial vehicle financing and project approvals, infrastructure investment may disappoint again, falling short of our 4% growth forecast and failing to offset a big part of the property investment decline.
Business confidence may weaken further due to a challenging regulatory environment or weaker growth prospect. Regulations may tighten in more business areas or applied more widely in 2022, as part of the ongoing change of regulatory framework. Thus, the decline in property investment and weak consumption recovery, and uncertainties related to the government’s stance on private sector amid the “common prosperity” strategy, may lead to further weakening of business sentiment and private investment.
Exports may beat expectation again. Global demand for China’s exports may again be stronger than expected in the cases of 1) continued strong demand for anti-Covid products due to the pandemic lasting longer, 2) a slower shift of domestic market consumption from goods to services, and 3) a longer global supply chain disruption or slower emerging market production resumption. Stronger export growth will help cushion the effect of a property downturn and Covid-related consumption weakness. On the downside, U.S.-China relations may deteriorate following the completion of the Phase One trade deal and ahead of the U.S. mid-term elections. Additional sanctions or other punitive measures by the U.S. may weaken China’s exports.
RMB may depreciate more than expected. Our baseline is for a modest RMB depreciation of 2% against the U.S. dollars in 2022. However, RMB may depreciate more (say more than 5% against the U.S. dollar) this year: With the Fed poised to tighten monetary policy more aggressively than previously envisaged and the China’s central bank set to ease, U.S.-China rate differentials could narrow more. In addition, weaker confidence on China’s growth and a challenging domestic business environment could lead to more net capital outflows. China’s export growth is expected to slow, and perhaps more than expected if U.S.-China trade relations worsen.
Wang Tao is the head of Asia economics and chief China economist at UBS Investment Bank.
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