China’s difficult balancing act: Achieving zero-Covid policy and economic growth

If you want to make God laugh, tell him your plans, so the joke goes. And the Chinese Communist Party (CCP) has announced them loud and clear. In 2022, the CCP will celebrate its 20th National Congress, which is set to extend the mandate of General Secretary Xi Jinping. And to mark the occasion, it wanted economic stability. Instead, it is facing a series of challenges: an economic slowdown, the real estate crisis and now, the war in Ukraine. But worst of all is the economic impact of the coronavirus lockdowns that have been introduced under the government’s zero-Covid policy, and which affect a quarter of the population.

China is today the only large economy today that maintains a zero-Covid policy, which involves tight border controls, limitation of movements and centralized quarantines. The policy is being applied for health reasons – the country’s health system is still very weak, especially outside the big cities, and would collapse in the face of a large number of cases –, but there are political motivations as well: over the last two years, it has been used to defend the superiority of China’s system of government over Western democracies. Thanks to its zero-Covid strategy, China was the first country in the world to report the end of the first wave of the pandemic and to start its economic recovery. Now, the lockdown of Shanghai, the economic heart of the country, is raising doubts about the policy.

The Chinese government set itself an ambitious target for 2022, announcing that gross domestic product (GDP) should expand by “around 5.5%.” But in light of the impact of the total or partial lockdowns, which according to the Japanese investment bank Nomura affect 343 million people (a quarter of the population) in 46 cities, analysts believe this figure will be difficult to achieve. The International Monetary Fund has downgraded its growth forecast for China to 4.4%, down from the 4.8% forecast in January. The World Bank has lowered its forecast from 5.4% to 5%. And Nomura has slashed its projections for the second quarter, from 3.4% to 1.8% for the second quarter, while yearly growth has been downgraded from 4.3% to 3.9%.

Macroeconomic data from the first quarter hint at the magnitude of the blow caused by the lockdown in Shanghai, where 26 million residents have been confined for more than a month. Although China recorded 4.8% growth, which was higher than what analysts expected, the figures for March – after the beginning of the Russian invasion of Ukraine and when the Covid cases began to skyrocket in Shanghai – are unequivocally pessimistic: consumption fell by 3.5%; unemployment remained at 5.8%, three tenths above the previous month and the official target for the year. China’s electricity consumption, a key barometer of economic activity, rose 3.5% year on year, compared to 5.8% in the previous two months.

Shanghai is only now beginning to ease restrictions following a week-long drop in Covid-19 cases. In the meantime, the city’s port – one of the busiest in the world – has reduced its activity by 40%, and ships waiting to unload container goods are piling up.

As a result, supply chains – already badly hit by the pandemic – have suffered a new and serious setback, which has caused a huge delay in the imports of raw materials and components, and in the exports of products. While 666 Shanghai-based companies, including Tesla, have been allowed to reopen, the Covid-19 controls are so strict that they are operating at a much slower pace.

“Although the lockdown is loosening, the economic impact is terrible,” said Alicia García-Herrero, chief economist for Asia at investment bank Natixis. According to García-Herrero, other economic measures, such as the government’s control over the technology sector, are compounding lockdown frustration and leading to “great discontent.” She added: “People who have money are seeing that things are going wrong. Who is going to want to invest?”

In addition to the lockdown in Shanghai, China has also seen a sudden rise in Covid-19 cases in Beijing, the capital. In this city, authorities have confined all residential buildings and complexes where infections have been detected, imposed limits on capacity in restaurants and closed cinemas and schools in several districts. In response, the yuan slipped to a 17-month low against the US dollar.

“The worst is yet to come,” said Lu Ting, Nomura’s chief economist for China, in a note. “Global markets have been slow to recognize the dire consequences of China’s zero-Covid policy.”

Concern is palpable among Chinese authorities. Li Keqiang, premier of the State Council, has ordered officials to “increase the sense of urgency” in implementing measures to activate the economy. The Chinese government has approved measures to speed up road freight transportation, while the Central Bank (PBOC) has reduced the amount of cash that banks must keep as reserves – although it has not cut interest rates so far.

But the Chinese government also wants to send a positive message, and has made it clear that they believe they will be able to achieve their ambitious growth target while keeping the coronavirus at bay. On Friday, the quarterly meeting of the Politburo of the Communist Party on the economy promised “to make great efforts to achieve our goals for this year of economic and social development.”

Last Tuesday, President Xi Jinping himself also emphasized the need to invest in infrastructure, a formula that Beijing has historically turned to as a means of addressing economic challenges. “Infrastructure is the bedrock for economic and social development,” he said. The Chinese president’s development plans include urban rail systems, regional airports, health centers, water and energy conservation projects and data storage centers, among others. “It’s the same story, but told in a different way. Now the emphasis is on innovation, the green economy, digital infrastructure,” said Huang Yiping, a professor of economics and finance at Peking University, in a digital seminar organized by the University of Sydney.

But investment in infrastructure alone will not be enough to ensure the government meets its targets, Natixis points out. According to the French investment bank, investment in infrastructure, “would have to increase by 18% to contribute its part to 5% [annual GDP] growth.”

“It is expensive and has little productivity,” added García-Herrero. Even if China’s nominal GDP growth were to reach 5% this year, the real growth would be much lower, “and that would be very bad news for the world,” she said.

Meanwhile, the consulting firm Trivium issued a document arguing that “with so many factors beyond Beijing’s control – Covid, the prices of raw materials, global demand – we believe that there are very firm limits to what Beijing can do” to reach its growth targets.

What is clear is that China is not likely to lift its zero-Covid policy, even if it is to the detriment of the country’s economy. Any change, in the eyes of the government, would jeopardize its credibility – and that stability that is important to the country. If the policy is loosened it will happen after the National Congress in November, when Xi’s mandate is set to be extended.

“They know what zero-Covid means for the economy. It’s just that they can’t use this knowledge to bring about policy change at the moment,” Joerg Wüttke, president of the EU Chamber of Commerce in China, said in an interview with the Swiss online newspaper The Market. “President Xi wants to be confirmed for a third term, so he cannot change his narrative this close to the finish line.”

Lu Ting agreed: “By emphasizing the zero-Covid strategy as a display of China’s governance superiority, it has made it more difficult to abandon the nearly impossible mission of eradicating the infectious omicron variant.”