Thu. Jan 27th, 2022

The author is Chief Economist at Bank of Singapore

How long will China be zero covid policy? The choice Beijing is making is one of the best game maps for 2022.

The consensus is that China’s position will ease after the Winter Olympics in February. It will boost consumption and stabilize the economy after its sharp slowdown last year. But Beijing is more likely to maintain its current strategy of strict restrictions and closed borders until the end of 2022. Strict controls in China will therefore continue to affect financial markets worldwide.

To see why, consider China’s calendar of major events. This year, the lunar holiday falls at the beginning of February. Beijing will then host the Winter Olympics before the National People’s Congress convenes next month. If Omicron outbreaks subside by the end of March, the government will have a clear window to facilitate pandemic measures and reopen the country to the outside world.

Reducing restrictions so early will support Beijing’s efforts to lift the economy. Last year, China experienced a V-shaped recovery with gross domestic product likely to expand by nearly 8 percent in 2021. But since the summer, growth has slowed sharply. Domestic consumption has been hit by strict restrictions to contain fresh Covid-19 cases. Industrial production was hampered by power outages. Real estate investment is limited by regulatory restrictions on property developers, and infrastructure investment is constrained by slow local government loans.

In December, the People’s Bank of China responded by reducing commercial banks’ reserve requirements to free up liquidity. The one-year benchmark loan prime rate fell for the first time in almost two years and the government’s Central Economic Works Conference promised more fiscal support. An early end to China’s zero-Covid policy will help further boost activity now, enabling the economy to have a good chance of growing at its 5.5 percent annual trend rate in 2022.

But Beijing is unlikely to abandon its strategy after the National People’s Congress in March. Instead, China will maintain its position until the 20th National Party Congress is held in November.

The latter congress is an important milestone in China, held every five years. This year’s event will be particularly significant as it will confirm whether President Xi Jinping will serve a third term.

It would then be surprising if Beijing runs the risk of easing its policy before November. His strategy has kept deaths impressively low, but reduced exposure is likely to have limited immunity among China’s population. In addition, the Omicron coronavirus variant could test the efficacy of China’s Covid vaccines. If Beijing abandons its strategy in the next few months, it could lead to widespread Covid outbreaks ahead of the National Party Congress.

Investors must therefore prepare for strict restrictions and closed borders in China to continue through the year. The consequences for global markets are likely to be significant.

First, consumption in China will remain subdued. The country’s GDP growth may fall below its trend rate in 2022, limiting the demand for commodities. The absence of Chinese travelers abroad will also continue to affect tourism-dependent economies across the Asia-Pacific region.

Second, China’s trade surpluses are likely to remain at record levels to the advantage of the renminbi. During the pandemic, China’s exports were driven by strong demand abroad, while imports were curtailed by slower domestic consumption. In 2022, emerging economies will face a stronger dollar as the Federal Reserve ends quantitative easing and considers raising interest rates to counter inflation. But the renminbi, backed by China’s external surpluses, is likely to remain stable against the dollar.

Third, the recovery of China’s record trade surpluses should help keep global bond yields low. This will be especially important for equities in 2022.

Stock markets soared during the pandemic as yields remained at historically low levels. But investors now fear that bond markets could fall if inflation does not decline. Paradoxically, Beijing’s zero-Covid strategy may favor risk assets here. By limiting consumption and imports and keeping trade surpluses high, China’s restrictive stance will enable its financial institutions to continue buying US treasuries, which will drive down the yield on government bonds abroad.

Some investors are hoping for an early exit from China’s strict virus control. But world markets can surprisingly perform better if officials make no changes until the end of the year.

Unsecured – Markets, finance and strong opinion

Robert Armstrong dissects the major market trends and discusses how Wall Street’s best minds react to them. Sign in here to have the newsletter sent straight to your inbox every weekday

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