China Outlook: Reopening Cyclical Upswing 2023 and 2024

• We do not see a major spike in CPI inflation, as demand will be moderate rather than huge and as global supply chains are now looser than 2021. PBOC will likely start monetary policy normalization in late 2023 with a marginal 10bps rise in the 7-day repo rate. Fiscal policy consolidation is likely in 2024, both given the focus on long-term debt trends and also to avoid a crisis in local government finances and central government having to bailout LGFVs. 

Our Forecasts

Source: Continuum Economics

China Reopening and The Recovery 

The most important development has been China’s population quick adaption to an endemic COVID policy, after the switch in December away from zero COVID. Furthermore, the massive reopening surge in COVID largely finished in January, which now provides some natural protection to the population alongside vaccines. This, all bodes well for the reopening of the economy and a pick-up in consumer services. The non-manufacturing PMI and February retail sales data suggests that this is already starting to occur in Q1. However, we do not expect a huge surge in domestic demand in H1 for a number of reasons. 

Firstly, China did not provide stimulus payments to households with the focus being on support for industry and business during the zero COVID phase. It is certainly the case that some measures of household deposits have picked up, but this could have been partially a precautionary crowding into safer banks during the uncertainty of the last couple of years. Additionally, China’s residential property market has been weak, which will likely have meant a decline in wealth, in contrast to the pick-up in household wealth seen in U.S./Europe in 2020/21. Thus, willingness to consume out of wealth is lower than in the U.S./Europe. Secondly, income growth needs to pick up with better employment growth, which will occur but will likely be spread over 2023 and H1 2024 rather than H1 2023. Thirdly, some switch of household spending from goods to consumer services will likely be seen, alongside the surge in demand for consumer services.

We still feel that consumption growth will lead GDP growth and help deliver 5.8% growth in 2023, it is just that we would caution against too much optimism. Residential property investment will likely start to stabilise after the difficult 2022, but conditions for a rebound are not yet in place. Property developers are still restrained by a hangover of debt; household push back against pre-payment and only soften of the three red lines policy (here). Household demand for housing also remains more restrained than before 2020. Elsewhere, private sector investment will likely pick-up in 2023 as the zero COVID policy is lifted and helped by central and local government infrastructure investment, but the message out of the authorities is that the state will be more actively involved in the private sector and this is likely to dampen new investment plans. Finally, net exports will likely be a drag, as the global slowdown hurt exports and energy imports rebound with services and more mobility around China.

One key question is whether CPI inflation will jump like other economies that have reopened. Our 2.1% CPI inflation forecast for 2023 reflects the view that the reopening boost will be smaller than U.S./Europe in 2021, while global supply chains are also more normal than 2021. Though some commodity prices will pick up, China is benefitting from buying oil from Russia at steep discounts. The low February CPI also means that China is starting from inflation below official desires. Even so, it will also be important for rural to urban migration to rebound to ensure that employment supply meets demand once slack has been used up this year.

The major downside risk for the economy is that the U.S. and West impose sanctions on China for supplying lethal weapons to Russia. This would impact demand for China exports, but also China role in global supply chains and cut exports out of the West. However, China authorities are aware of the risk and this is a low probability scenario.

Figure 1: China Urban Unemployment rate (%)

Source: Datastream/Continuum Economics

China’s authorities have been clear that policy will support the recovery through 2023, with a 25bps RRR cut being delivered in March. Fiscal policy stimulation will be less than the large 2022 tax cuts/rebates, but will still be helpful. Additionally, large banks will continue to be encouraged to support growth through lending and low teens percentage total social financing growth will likely be evident. Going into 2024, monetary policy will likely see some slow normalisation with a 10bps increase in the 7-day repo rate in late 2023 and further 30bps in 2024. Fiscal policy will also likely switch to consolidation in 2024 (here), both as China seeks to preserve fiscal space and as the long-term worries of excess debt leads to less generous policy.

For the economy in 2024, the reopening benefit will fade and this means that H2 will likely be more normal. Additionally, as noted, we expect the policy environment to be a mild headwind rather than a tailwind. The global economy recovery will help net export via exports of goods, but this will only a partial offset. We see the risks around our central forecast of 5.5% as being balanced, depending largely on how much policy consolidation takes place. However, we do still look for trend growth to slow through the 2020’s to below 5% and eventually 3-4% by 2030, as we highlighted in last November long-term forecasts (here). China strategic competition with the U.S. is also a headwind, as it means that certain industries risk losing momentum with U.S. sanctions and blacklists (here).