How China can get its economy back on track after the 2021 battering

This has been an unusual year for the Chinese economy. As it recovered from the most catastrophic shock in modern history, annual growth rates in the first half appeared buoyant but mostly reflected favourable base effects. As the year progressed, the economy was battered by a series of natural and man-made shocks. Resurgences of Covid-19, severe flooding, a cooling housing market, soaring commodity prices and a severe power shortage all took their toll on the post-pandemic rebound that was already losing steam due to lacklustre domestic demand. A series of punitive regulatory tightening measures added to the economic woes and posed a setback for financial markets. Looking ahead to 2022, the economy is likely to be buffeted by many of the same factors, which can be categorised into three groups: the transitory, the persistent and the uncertain. In the transitory camp lies the adverse-weather effect and the impact of power shortages. The latter contributed to the third quarter’s economic slowdown by disrupting industrial activity and creating blackouts for many in the worst-hit regions. Thankfully, the authorities have responded swiftly. A concerted effort to raise coal production for thermal power generation, widening the electricity price band, and a determined crackdown on coal speculation have all helped to limit the impact of this transitory shock beyond the end of 2021. In contrast to the short-lived power crunch, the housing market correction is set to exert more persistent pressure. In retrospect, the introduction of the “three red lines” for major developers – caps on the amount of debt they could hold in relation to cash on hand, the value of their assets and as a proportion of equity in their businesses – may have marked a turning point in Beijing’s attitude towards the sector given President Xi Jinping’s comments that “housing is for living in, not for speculation”. Underscoring this shift in attitude is probably a recognition that housing development has become increasingly incompatible with many of China’s long-term strategic goals. As an amplifier of wealth inequality, the growing housing bubble is a major impediment to “common prosperity”. Housing construction, along with its upstream industrial sector, are the two biggest emitters of greenhouse gases, making them a target for decarbonisation. Chinese cities are skirting around Beijing’s tight property rules Finally, housing is an unproductive asset that produces no output and employment after completion. This contrasts with building a factory, which creates jobs and productivity thereafter. Hence, a reallocation of resources away from housing to productive sectors should be beneficial for the economy as a whole. However, reallocating resources from a sector that accounts for a quarter of the economy necessitates careful planning and execution. Against rising economic headwinds, the authorities have started to fine-tune policies lately to ensure that the pursuit of long-term objectives does not imperil short-term stability. This is no policy U-turn, but a “two steps forward, one step back” approach to balancing objectives across horizons. Finally, the uncertainty around Covid-19 remains the biggest domestic risk. This is not limited just to how the virus will evolve by itself and in relation to vaccines, but also how China’s virus-fighting strategy will change as more countries decide to “live with Covid-19”. Periodic lockdowns against even a small flare-up of infections have come at great cost to the economy, inhibiting consumption and service recoveries. Despite the apparent costs of “zero-Covid”, Beijing is unlikely to change its approach any time soon for social and political reasons. Recent experiences of countries moving towards “living with Covid-19” have all resulted in a sharp surge in local infections. China rejects ‘living with Covid-19’ model even as spikes get ‘more common’ While that may be necessary to achieve collective immunity, such a cost could prove grave for a Chinese population living effectively Covid-19-free since mid-2020. Any drastic policy changes that reignite public fears of the pandemic could be seen as a colossal mistake by the government. Beijing is therefore unlikely to deviate from the status quo unless further major medical breakthroughs are achieved. To balance the economic shocks, official policies will prove critical. Those have been uncharacteristically tight this year, reflecting Beijing’s higher pain threshold underpinned by a recognition that many of the structural developments China is pursuing – including common prosperity and higher-quality growth – would inevitably create short-term pains. And those pains are better faced by a cyclically strong economy, bouncing off the Covid-19-induced low base. However, the macro environment has changed. With the growth momentum fading, the authorities cannot afford to continue with policies that risk driving the economy into a hard landing. A wholesale recalibration of macro operations is therefore needed for next year, which could consist of more lenient regulatory policies, more accommodative monetary policies – focused on targeted liquidity injections and credit growth stabilisation – and more front-loading of fiscal stimulus. As these put a floor under the economy, growth should gradually recover from a cyclical trough to average 5 per cent for 2022 before rising gently to 5.3 per cent in 2023. Aidan Yao is senior emerging Asia economist at AXA Investment Managers