Moreover, the first quarter numbers do not likely fully reflect the impact of recent lockdowns in Shanghai and elsewhere. That impact will probably show up in the second-quarter numbers. Meanwhile, there is no indication that, despite the economic disruption, the authorities have any intention of reversing or easing the zero–COVID-19 policy that has disrupted the economy. That, in turn, raises questions about how China will be able to get back on a favourable path.
Let’s look at the details. In the first quarter of 2022, real GDP was up 4.8% from a year earlier, slightly better than the 4% growth clocked in the fourth quarter of 2021. Real GDP was up 1.3% from the previous quarter, which is an annualised rate of 5.3%. This was slower than the 1.6% quarterly growth clocked in the fourth quarter of 2021. By output category, the government reported that industrial production was up 6.5% in the first quarter versus a year earlier, including a 6.2% increase in manufacturing output. The services sector, however, grew only 2.5% in the first quarter. However, IT-related services were up 10.8%. Retail sales were up 3.3% in the first quarter.
Data for March, however, showed a worsening situation, likely due to the pandemic-related measures taken by authorities. Thus, retail sales fell 3.5% in March versus a year earlier after having grown strongly in the previous month. This was the first decline since early 2020. By major category of spending, sales were down 6.3% for cosmetics, down 12.7% for clothing, down 17.9% for jewelry, down 7.5% for automobiles, and down 8.8% for furniture.
China’s industrial production was up 5% in March versus a year earlier, much slower than in the previous two months. While some categories of production did well, automotive output fell 1%. In addition, business fixed investment decelerated sharply in the first quarter.
What happens next? Given the severe lockdown in Shanghai, a city of critical economic importance to China, and given restrictions imposed in many other cities recently, it is likely that second-quarter growth will be modest at best. Meanwhile, the decline of the property sector continues, thereby slowing growth even in the absence of pandemic-related problems.
Moreover, the government appears keen to take a strong stand against the virus. It was reported that Chinese media stated that “only one can live and the other must die” in the fight between humans and the virus. This goes against the epidemiological notion that humans will have to find a way to live with the virus, as has been true with pandemics in the past. Yet if the policy is to fully eradicate the virus, it does not bode well for returning to normalcy, in terms of economic performance, interaction with the outside world, and the ease of doing business.
Therefore, the COVID-19 crisis in China could be the most serious threat to the global economy at present. There is no indication that the strict government response to the outbreak is likely to abate any time soon. Shanghai remains in severe lockdown. On April 20, the authorities said that the outbreak was under “effective control” and agreed to let roughly half the population of Shanghai leave their homes. Then, on April 22, many restrictions were reinstated. Those who test positive are required to stay home. Many residents are having trouble obtaining food and other necessities, especially given the severe disruption of delivery services.
At the same time, more than half of China’s big cities are under at least partial lockdown, including cities that are critical to global transportation, such as Shenzhen, Guangzhou, and Tianjin. Lockdowns entail massive and frequent testing, meant to identify and isolate those who are infected. This comes despite the high vaccination rate in China. Yet the Chinese vaccine is not highly effective.
The result of these measures is twofold. First, production and distribution of goods have been severely disrupted, thereby reducing global supply chain efficiency and setting back progress on alleviating global disruption. This, in turn, will likely exacerbate global inflation and reduce global output. Second, the lockdowns are reducing domestic demand in China, thereby contributing to a marked slowdown in economic growth. One positive side effect of this could be a sizable decline in demand for globally traded commodities, thereby helping to reduce global inflationary pressure.
The big question remains as to how long this situation will last. Statements from government authorities offer little hope of a change in policy. Rather, China appears to be doubling down on the zero–COVID-19 policy. So long as the policy remains in place, it is likely that economic activity will be suppressed. Keep in mind that the Yangtze River Valley surrounding Shanghai accounts for about one-fifth of China’s economic activity. The lockdown of Shanghai severely limits activity in the region.
For global businesses that operate in or source from China, this situation creates a new layer of uncertainty and disruption. In my past life of frequent travel, I would often meet, in airports and on planes, business executives on their way to and from China. They needed to periodically check on factories and distribution hubs, negotiate contracts, explain new policies, and get an in-person reading of the local market. How will this take place if travel is severely restricted for a prolonged period? Indeed, these considerations are likely to accelerate the process of diversifying supply chains.
In recent meetings, clients have asked me where companies might go as they attempt to make supply chains more resilient and redundant. It was suggested that India might be a favourable alternative given political and economic stability, low labour costs, and strong IT skills. However, India has its own challenges and obstacles including relatively high barriers to trade and cross-border investment as well as weak infrastructure. Still, India is increasingly central to the US goal of offsetting China’s footprint in the region. Given its massive size, India could become a major destination for global investment if companies seek to reduce dependence on China.
Expected weakness of China’s economy is likely one of the factors lately contributing to increased capital outflows and downward pressure on the value of the currency. Other factors include the tightening of US monetary policy, the global rise in commodity prices, and fears of further tensions between China and the West in light of the war in Ukraine. Based on conversations I have had with clients, it appears that there is apprehension among business leaders about reliance on Chinese supply chains. I suspect that the diversification of supply chains is likely to accelerate in the coming year.
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