Podcast

Paul

Hello, and welcome to macro bites the economics and politics podcast from abrdn. My name is Paul Diggle, Deputy Chief Economist here at abrdn. And today we're talking about China, the rebound after the Shanghai lockdown, the challenges of sticking with zero Covid and what happens after the 20th Congress where President Xi Jinping hopes to secure an unprecedented third term.

And I'm very pleased to say we have two great guests joining us in this discussion. Adam Wolfe is the Emerging Market Economist and China Specialist at the macro market consultancy Absolute Strategy Research with a deep background in covering the Chinese economy and politics - and Robert Gilhooly. Bob is the Senior Emerging Market Economist here at abrdn, and previously he ran the Bank of England's forecasts for the Chinese economy. So two real experts, and we're going to learn a lot. Adam. Bob. Welcome to the podcast.



Thanks for having me.

Paul

So, Adam, let's start with you, and let's talk a bit about the rebound, the economic rebound, out of the Shanghai lockdown in China. How strong is that rebound proving to be as the economy reopens? Is the data doing well? Is it stronger or weaker relative to previous emergence from lockdowns in China?

Adam

Well, so far, we have seen a pretty strong reopening effect since the very beginning of June, because we had Beijing, Shanghai, and Jilin and other cities, all reopening basically the same time. And so subway traffic and other high frequency data, all, show this really abrupt jump in activity when that happened. But since then, it's kind of levelled off. And activity looks to be about more normal levels. You know, on top of that, there are some signs that we're seeing pent up consumer demand being released, at least in the June data, with auto sales jumping by about 20% year on year after contracting the previous two months. But I think from here, it's really unclear which way the economy is going to go. Most importantly, I guess the big question is, is China going to stumble back into a lockdown situation?

You know, do we have these newer variants of Omicron spreading that look like they're more contagious, and just in the past week or so we've seen Shanghai and Xi’an and a few other cities reimposing some restrictions. And so if cities do go back into lockdown, then growth is obviously going to suffer again. And I guess another question would be, beyond this reopening effect, how much damage has zero Covid and these kind of periodic and rolling lockdowns, how much damage has that done to consumer sentiment? Because if you look at the survey data from Q2, it was just pretty much awful across the board. You have record low consumer confidence, record low confidence in household incomes, record low bank loan demand, everything was basically at record lows. But obviously that was distorted by the lockdowns in the largest cities. And there are some signs in the harder data of an improvement with housing sales picking back up, loan growth looking relatively strong in June. And so it does seem like sentiment is improving. But I think that there's probably an upper limit to how much that sentiment can improve, and so how sustainable this recovery can really be from here.

Paul

Absolutely, and so Bob, are you expecting this recovery to be durable when zero Covid is still in place? I mean, we were already seeing, as Adam highlighted a few areas and cities experience renewed outbreaks of Covid. How long can this rebound continue while we've still got the zero Covid policy ongoing?



Yeah, I think at least in the near term prospects seem reasonably good, and I agree with a lot of what Adam has just said, I mean, just the normalisation of activity, to some extent, should drive a fairly decent sequential rebound in terms of growth going into Q3. You know we’re still expecting contraction in Q2, but obviously, a lot of depends on how frequently these restrictions and lockdowns are going to be needed to maintain the dynamics zero Covid. I'm certainly hopeful anyway, that this more highly attentive policy would avoid the disruption on the kind of the scale that we've seen in Shanghai going forward, but I do still think it implies fairly frequent targeted restrictions, which could average out to some moderate headwinds, but shouldn't necessarily impede that overall recovery. But you raised the question of how durable it is well, I guess it's not just the zero COVID that's dominating our view at the moment, but also how China proceeds also with other sides of the regulatory changes around property, which still looks very, very weak, how China’s potential as well is faring. So we go into 2023 and potentially whether US recession risks crystalize as well, towards the towards the end of the year so there's a lot of, I think, big risks on that front.

Paul

Let's get into some of those questions, then that'll affect the durableness or otherwise, of this recovery. And as we've been saying, how long zero Covid actually remains in place is clearly absolutely critical. And what needs to happen then for China to eventually turn away from zero Covid? What do authorities need to do to eventually pull back from the zero Covid? Is it just more vaccine rollout? What are we wanting to see?

Adam

It's a little bit difficult to say I think, just because it's as much of a political decision as it is a public health decision. So, you know, on the politics side, I think it's pretty clear. We have the National Party Congress later this year, where the top leadership is going to be turned over. So that seems to suggest that we're not going to see any major change in policy before October or maybe November at the earliest.

Paul

Just because they want they want political stability ahead of that that important Congress. Right? They can't afford a huge outbreak.

Adam

Yeah, exactly that you wouldn't want to go into that Congress with an outbreak underway. But and then on the public health side, I think you're right, the key criteria has to be vaccination rates. So some studies based on the recent outbreak in Hong Kong suggested that Chinese inactivated vaccines do work about as well as an RNA vaccines, but only with the booster jab, with two doses, they don't work nearly as well, for whatever reason. But you know, so China's vaccination rates are very high with more than 90% of population having two jabs, but less than 60% actually having the booster jab. And for those over 60, you know, only 80% actually got two jabs, but a little bit more than 60 have actually had been boosted. So they're a little bit better on that side. And I think that you would have to see at least 85% of those, especially in the over 60 age bracket being fully boosted before there could be a significant relaxation of policy.

Paul

Is that a quick process? Because one kind of imagines Chinese policymakers as being able to do mass programmes like that, at speed. But it sounds like actually its gone more slowly than in many other economies?

Adam

Yeah, I think the problem has gotten worse lately, not better and part of that is because as we saw these outbreaks in Shanghai and Beijing, that's really encouraged other cities beyond just the two largest to ramp up their mass testing protocols. And that's redirected a lot of resources from vaccinating people to testing for Covid. And so they really need to find a way to do both, which means that it just puts even more fiscal pressure on local governments who are struggling to cope with a collapsing housing market, and falling tax revenue due to all of these tax rebates that they've done to offer stimulus for this year. So the pace has slowed to the extent that it's probably going to be the middle of next year, if they keep this pace that they could hit some sort of 85% vaccination rate and feel confident that they can reopen the economy more safely.

Paul

But are there chances that even that timeline, that mid-2023 reopening slips say if China want to do an on Omicron-specific vaccine, you know, are there risks that zero Covid becomes a semi-permanent feature of China?

Bob

Probably not, probably not semi-permanent, but I think there is a pretty good chance zero COVID actually persists for longer. It's my central case that they will move away from it a bit after the 20th Congress, but I do see a few key risks. I mean, first of all, they've set themselves a very high bar with the focus on zero. So given the high transmissibility of Omicron to some extent it's probably a bit of an all or nothing move, and they need to be ready for very high case numbers stemming from that move. So the idea that you could kind of remove restrictions in some areas and keep Covid out of others seems like wishful thinking. So I think that really requires you to be constant so you can deal with those large case numbers. We generally believe there's worse health care coverage in rural areas, these also have a slightly higher share of the elderly population in them. So you know, that could delay relaxation, if you want to say improve emergency facilities such as ICUs and / or ensure adequate supplies of the Covid pill which they don't really currently have to reduce these kind of health care strains. I'm not quite sure of the very latest numbers but as of about April, China had about 400 makeshift hospitals with capacity for about half a million in the process of being constructed or being near to being constructed. So it's possible that that's a little bit of a barrier. I mean, briefly going to your point about the semi-permanence - if you were to go a little bit more, slightly more, conspiracy theory like, one might wonder whether testing itself has actually created some sort of vested interests within China. So you know, it's estimated there 11 billion tests conducted in Q2, but a quarter of a million testing booths also constructed. I mean, I'd roll back that conspiracy, I think on a slightly more serious note, you know, the point is just they've invested a lot in this infrastructure, maybe at the margin, that might keep you going with zero Covid for a little bit longer, because you've of already got the infrastructure set up and in place.

Paul

If nothing else, as Adam says, it pulls resources away from the vaccine rollout itself. So let's talk then about fiscal and monetary policy support, which has been done in China partially to offset this negative economic drag from Covid. And Bob, we're talking on a day when China has just printed some pretty strong credit growth numbers. What are authorities doing exactly in terms of offsetting policy support?

Bob

Yeah, you know, over the course of this year, we've seen PBOC easing a bit at the margin. I think the really big trend, is the kind of increasing policy pivot towards fiscal support. So I think there is a broadly consistent view that monetary policy has been a bit ineffective in countering the supply shocks and Covid-related restrictions that have been put in place. But you know also illustrative. I think the authorities still want to hold the line a bit on de-risking, particularly real estate there. So a bit wary of kind of pump priming the economy to aggressively when you're facing a big supply shock. You mentioned it there Paul - consistent with that shift to fiscal, we’ve just got the Chinese credit data - super strong in June coming out almost 5.2 trillion rmb definitely helped by the government’s drive to issue 2022’s local government bonds, by the end of June and indeed that pushed up government bond issuance and credit data to a record high of 1.6 trillion. And you know, I think, most interestingly, and it's not been confirmed, but we've had reports by Bloomberg that Chinese authorities are considering moving around about 1.5 trillion rmb of 2023’s special local government bond issuance into the second half of 2022. And that's quite an unusual move. You know, normally, the special local government bond issuance brings maybe forward a bit of issuance, out of the fiscal year into more the calendar year series from March to January period, but moving it into the second half this year, I think really speaks about additional fiscal stimulus, rather than just a kind of simple reprofiling, as it's kind of being badged or kind of mulled over at the moment.

Paul

Adam, should we should we think of this stimulus, then as fully offsetting the drag from zero Covid? Is China in that sense, a net positive for the rest of the world, the global economy, or is it the case that while you've still got this health situation going on, it's very hard for credit stimulus, for fiscal expansion to gain traction? How should we think about that, that balance?

Adam

I mean, I think so far, most of the stimulus that we've seen out of China has really been aimed at balance sheet repair, or keeping businesses in operation - and not really at juicing up activity. You know, and on that front, on the monetary side, it's been somewhat less effective than on the fiscal side, we've seen a lot of the monetary support really getting trapped in the financial system. And so interbank rates are very low. But up until June, anyway, credit growth had been pretty sluggish. And on the fiscal side, you know, things have been a bit more helpful, but a lot of that stimulus has come from just tax cuts, you know, again, reducing the burden for businesses so that fewer will go out of business as a result of this slowdown. You know, in terms of juicing up demand, really, that's just concentrated on infrastructure financing, which is kind of a classic Chinese playbook. And that should provide some offset for the construction sector, from this contraction in property investment, but net net, that's not going to create a lot of demand for the global economy. But I do think you know what, what Bob was talking about is probably important for the next six months is that China's fiscal support is really running out of room in a lot of ways. So China runs or manages its fiscal system around this system of bond quarters where the Ministry of Finance puts out a number for how many bonds it's going to issue for the year, and no matter what happens with the real economy, that's how many bonds they issue. And because growth has been worse than expected, you know, local governments have exhausted this year’s quota already. So unless that quota from 2023 is brought forward, or the 2022 quota is expanded, local governments are facing a fiscal cliff basically for the rest of this year. And then next year, the Ministry of Finance itself faces a pretty severe fiscal cliff, because it raised about 3 trillion renminbi from other one off revenue sources, like the PBOC contributed over a trillion renminbi from its profits over the last three years to the government this year. And other measures that it just won't be able to repeat. And so they really need to figure something else out to keep the support going for the next six to nine months, otherwise, the fiscal policy is going to run into a wall.

Paul

So let's talk about politics then, because the 20th Party Congress is coming up, it's in I think, October, November time, we don't have an exact date at this point. And the big event, obviously, at this 20th Party Congress is going to be Xi Jinping securing, attempting to secure, an unprecedented third term. Adam, is that third term guaranteed? I mean, how has the recent performance of the economy, the renewed Covid outbreaks, or any of those, weakened his position in any material way? Or should we basically count on this third and possibly a future fourth term for Xi Jinping?

Adam

Yeah, I know that there have been a lot of media reports about Xi’s position is weakening, because the economy is contracting, zero Covid looks like it's failing and aligning China to Russia, doesn't look like a great decision at this point in time. But I do think that Xi’s third term is pretty much locked down. And there's no real credible threat against that. And that's really, because the Communist Party, you know, it's obviously set up along communist lines, where you have this top down control, and then penetration of the party into all aspects of society. And so in those Leninist systems, there's really two levers of control. You have organisation of the party or control of the personnel within the party running the party. And then you have ideology, which controls the balance for debate. And Xi has really demonstrated his control of both of those levers over the past year. So in terms of organisational control, I mean, the most obvious example of that is the never ending anti-corruption drive, which just keeps any potential challengers in line. But we can also see that by looking at the turnover, the provincial level, party leaders, which just concluded last week or the week before. And so 19 out of 31 of those leaders were appointed to the position in the last 18 months. And 16 of those leaders now have some sort of biographical link to Xi, meaning that they either worked with him in some previous posts in the past, or in some cases, because Xi is getting older, they worked for one of his deputies. And that's up from 10 leaders ahead of the 2017 National Party Congress. So you know, increasingly, the party elites are all coming from Xi’s team, if you want to call it that. And then in terms of ideological control, you know, the party passed a resolution on party history, in November of last year, which was only the third time they published a document like that. So it was a pretty big deal. And the big takeaway from that document was, what the party itself is calling the two establishments. So it established Xi at the core of the party, and it establishing Xi Jinping thought as the guiding position of the party. And so, you know, given the his control over organisation and ideology, there's just no way that a challenge can really emerge to push him aside.

Paul

How much should we read into the likelihood of Xi assuming the Chairman title, so putting him on a, on a kind of level with Mao in the Communist Party pantheon? I mean, is there is there a significance in that honorific?

Adam

I mean, I guess the honest answer to that would be I don't know. I don't know if he'll go for that. I don't know if it will matter, to be honest. I mean, Xi Jinping thought now is written into the party Constitution, has been established as a guiding ideology, so even if Xi were, for whatever reason to make the decision to follow Deng Xiaoping's lead and step back from a formal leadership position now he will still be the most important political actor in China, I think. And so it doesn't really matter what title he takes, I guess one way of interpreting that might just be to say 3 terms won't be enough for him, he's going to be the leader for life.

Paul

So continuing that that sort of Kremlinology or Beijingology, then Bob, what do we know about the composition of the Politburo, those people immediately under Xi, do they tell us something about his willingness to go for a fourth term or whether sort of heirs and successors are emerging from within the party machinery?

Bob

I think I think we, we might be able to kind of read the tea leaves a little bit on this one once those have been confirmed. You know, that should give a bit of a sense about whether there's a kind of viable successor, someone who would largely kind of carry on probably Xi’s vision and Xi Jinping thought, but at the moment you know, we're just in a basically in a wait and see, we need to see what that composition of the Politburo is going to look like. I mean, interestingly, as well, on that one, there's quite a few people in the standing committee and kind of slightly lower down in the political hierarchy, who are coming up to what you would normally considered retirement ages. So there could be some fairly big reshuffles there in terms of the Premier or other quite important posts within the within the Communist Party. But yeah, I think we're in a wait and see as pretty much everyone I speak to on Chinese politics says it is very much a black box, and we just don't really have very much light onto it at the moment.

Paul

Yeah, absolutely. So let's, let's try final section then and let's talk a little bit about what that third term might hold and what the direction of policy might be in China, beyond the Congress later this year. And Adam, in the past couple of years, the regulatory and tech crackdown has clearly been a big theme, sort of supplanted by zero Covid more recently, but I think that crackdown had a large impact on markets. Was that a one off, or are regulators coming for other parts of industry next?

Adam

Well, I think it was a one off in the sense that we're not going to have that exact round of regulation again, and then not necessarily aimed at those same companies in the second round. But I do think it's a symptom of the party establishing a much more direct kind of guiding hand for the economy going forward. And I guess that fits within Xi Jinping’s vision of where he's trying to push the country as a whole, over the next 15 years, or however long he plans to stay in office. You know, with, I guess, his vision of what he's trying to accomplish, I think you can kind of put into three bullet points. So the, you know, obviously, the ultimate goal is national rejuvenation, or, you know, China reestablishing its global leadership position. And the next would be that, right now we're going through this period of significant geopolitical and technological changes – or what the party always calls changes unforeseen in a century, or unseen in a century, which creates this opportunity for China. And so what Xi has really been pushing, or the top leadership of the party has been pushing, is that everybody needs to pull behind Xi Jinping’s leadership to seize that opportunity. And I think it is that final step that's really gonna guide everything that, you know, within industries, especially those that touch technology or manufacturing, if they're falling out of line with that vision for the future, we will probably see more regulatory pressure on those industries going forward.

Paul

And what about growth targets, then, Bob, so China's fairly unlikely to meet its growth target this year, given the weakness earlier on? Is China post growth targets and focusing on other policy priorities – or are they still going to be a big part of what the economy is doing?

Bob

Yeah. It's a really good question. I think for now, they're still kind of clinging on to the growth targets. But you know, we have seen this gradual shift in policies and emphasis from the authorities, more emphasis on social cohesion, just common prosperity, and then more emphasis as well on what I call resilience. So that could include both the domestic economy in terms of de-risking property, but also more resilience, less dependence on the west, and that fits the mold of dual circulation, as well. You know, there may be a few hints here that the growth targets certainly matter less than they used to. I mean, last year's growth target of 6% was amazingly easy to hit. If there'd be no quarter and quarter growth from Q1 to Q4, GDP still would have come in at 6%, just due to the base effects. So you know, that could hint maybe a little bit, the growth targets are on the way out. That said, I'd be a little bit surprised at some of the recent reaffirmations of this year's target. You know, as you've said, doesn't look to us like it's going to be out of sight. And then also external shock proofing the economy to some extent, you know, including kind of making it more resilient to tensions with the US. That might well be a cost that authorities are willing to pay. But we do also need to be a bit mindful, there's still kind of various high level policy goals around growth, such as making China a moderately prosperous society, and some of these are, of course, still dependent on growth rates remaining very high. And probably, just to add on to that, there's still a geopolitical element to growth too. China’s hard and soft power is directly related, I think, in many ways to the size of its economy. So there are still reasons to go for growth, in that sense too.

Paul

Brilliant. Adam Wolfe from Absolute Strategy Research, Bob Gilhooly from here at abrdn, thank you both for some fascinating insights. Certainly some interesting months and years to come for China and its impact on the world. And thank you too you for listening to Macro Bytes. We'd love you to like or subscribe to the podcast on your platform of choice. But until next time, goodbye and good luck out there.

This podcast is provided for general information only and assumes a certain level of knowledge of financial markets. It is provided for informational purposes only and should not be considered as an offer, investment recommendation or solicitation to deal in any of the investments or products mentioned herein and does not constitute investment research. The views in this podcast are those of the contributors at the time of publication and do not necessarily reflect those of abrdn. The companies discussed in this podcast have been selected for illustrative purposes only or to demonstrate our investment management style and not as an investment recommendation or indication of their future performance. The value of investments and the income from them can go down as well as up and investors may get back less than the amount invested. Past performance is not a guide to future returns, return projections or estimates and provide no guarantee of future results.

GB-150722-177901-44