Bottom line: Downside growth risks are growing with the spread of omicron through Beijing. We could have to revise down our 4.5% growth forecast to 4.0% or 2.0% in the worst case of major lockdowns across the country. Further monetary policy easing is likely to be insufficient to stimulate the economy, and we look for yuan depreciation to be used. We are revising our end-2022 USD/CNY forecast to 6.75 from 6.30.
Figure 1: Yuan Weaker Trend in 2020
Source: Datastream
Beijing is seeing strict restrictions for 3.5m people after a surge in cases over the weekend, prompting fears that Beijing could follow Shanghai into full lockdown. Additionally, with the Shanghai lockdown having been extended, the concern is that a Beijing lockdown may not be short.
We have previously highlighted our concern that the omicron variant is very difficult to control, which is evident in many countries but clearly in Hong Kong earlier this year. The dynamic zero-COVID strategy will find it difficult to achieve success, as has been shown in the continued extension of Shanghai lockdowns. With omicron also in many other provinces at low reported levels, the national risk of spread remains.
This produce downside risks to our 4.5% growth forecast for 2022, which we cut from 5.0%. The question is how much. Worst case, a series of city and province lockdowns could cause a 2020-style hard landing and growth could be 2.0% for 2022. A less severe scenario of a Beijing lockdown and mid-May Shanghai reopening could mean a 4.0% growth trajectory.
Much also depends on further policy stimulation. So far China policymakers have undertaken modest easing, as they are concerned about the long-term debt dynamics in China. We do see further monetary policy easing and project a cumulative 20bp cut in LPRs in the coming months — including 10bps in May. More important is official pressure to increase lending, which we feel will produce a pickup in total social financing growth to 10% y/y. However, new fiscal policy measures will only be modest, meaning that China’s authorities need to consider other measures. We do see yuan depreciation as being one of these tools, and this is what happened in 2020 (Figure 1). Additionally, the real trade-weighted exchange rate is overvalued after the surge post-2007 and is up 35% since January 2010 (Figure 2). Long-term, China wants a better balanced economy, but over the next 12 months a weaker exchange rate could provide some stimulation. Thus we are revising our end-2022 USD/CNY forecast to 6.75 from 6.30. The authorities will want this to be a slow pace of depreciation rather than rapid, however.
Figure 2: Overvalued Real Yuan Trade Weighted Exchange Rate (January 2010 = 100)
Source: Datastream
