China’s economic future faces various threats, not least from internal crackdowns, Covid policies, and a president who may unintentionally strangle growth. Our overseas investing expert considers prospects for the Middle Kingdom.
It took decades for the sleeping giant that was China to stir and join the global economic order. Having stormed up the world rankings to second place, the country is now in danger of withdrawing back into the twilight zone.
After lurching between conflicting policies under Chairman Mao, China went through a period of stability and comparative liberalism that promoted double-digit economic growth and fed a growing appetite for consumerism.
President Xi Jinping has gradually assumed similar power to Mao and there is a serious danger that, surrounded by yes-men, he will unintentionally strangle an economy that has already seen growth shrink to less than half its peak levels.
Perhaps stung by accusations that it was the original source of the Covid-19 pandemic, China embarked on more strict lockdowns than any other nation. Now, while the rest of the world is learning to live with the virus, Xi has been prepared to continue shutting down entire cities, apparently ignoring the damage that is doing to China’s vital position as the central hub in the global supply chain.
The lack of immunity to Covid among the Chinese population is likely to be a continuing problem. Few Chinese have been vaccinated and those who have been have received an inferior home-grown vaccine that had limited efficacy against the earliest strains and little, if any, against later mutations. It is hard to see how China can now open up without seeing its hospitals overrun by an avalanche of Covid cases. There are simply not enough critical care beds to cope, just 3.6 per 100,000 people, which is roughly half as many as in the UK and a quarter of the level in the US.
The position is further complicated by the notoriously inaccurate collection of statistics, with numbers of infections and deaths from Covid-19 almost certainly being widely understated.
China experts widely accept that clampdowns have taken their toll on the economy, leaving Xi with less room to manoeuvre. The International Monetary Fund (IMF) forecasts 3.5% growth this year and, while economic forecasting is an error-strewn art, we now have enough economic data for 2022 to realise this is probably an overstatement. Economic growth was only 3% in the first three quarters of this year, well short of China’s own annual target of 5.5%.
Exports, the main driver of growth, were down 8.7% in November compared with a year earlier. Another driver, the property market, has slumped and could put a strain on the banking system.
This clampdown is so severe that it has prompted a rare show of dissent in various cities across the country. While protests in China tend to be put down with considerable severity, as those who demonstrated in Tiananmen Square and Hong Kong will attest, social unrest on this scale has arguably not been seen in the country since the civil war ended in 1949, and it will surely prey on the minds of Western company executives thinking of stepping up investment there.
Earlier in the phenomenal period between 1980 and 2019, when economic growth averaged 8%, China gained a justified reputation for stealing technology and intellectual property rights from developed Western countries desperate to get a slice of the action in the world’s most-populous nation. By the time the West woke up, China had created advanced technological companies of its own such as Alibaba Group Holding Ltd ADR (NYSE:BABA) and Huawei.
China’s economic future now faces various threats at a time when it has decided to flaunt Western opinion by refusing to criticise Russia’s invasion of Ukraine and is threatening its own invasion of Taiwan. The suppression of free speech in Hong Kong has raised questions over its reliability in upholding treaties and the “re-education” of the Uighur minority has stirred liberal consciences overseas.
This is particularly dangerous given that China’s economic growth has been heavily predicated on exports rather than satisfying growing consumer consumption at home. We may well see a shift in this balance, prompted by unease at home and abroad.
It will take some time to wean the West off a reliance of supplies created by cheap Chinese labour, but that time could at last be coming.
Dave Nicholls, who runs the widely backed Fidelity China Special Situations (LSE:FCSS) investment trust, has been quoted in The Times as calling sentiment towards the Chinese stock markets “dire” and “probably the worst I have seen”. He noted that a number of foreign investors had been selling down their China holdings.
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China has in the past been unhesitant in quelling dissent, but the sheer scale and spread of the demonstrations and the unprecedented calls from demonstrators for Xi to step down looks to be provoking a rare display of compromise in this case.
Quarantine times have been shortened and in more than 20 cities, including Beijing and Shanghai, the requirement for commuters to produce a negative Covid test before taking public transport has been removed.
Vaccinations for the elderly will be stepped up from a very low base, but throughout most of next year and possibly into 2024, China will remain the only sizeable country trying to eliminate Covid-19 through zero transmission rather than herd immunity.
Freeing the country of Covid restrictions and a measure of social liberalisation would make investing in China more appealing, since the large domestic market offers better immediate prospects of economic growth rather than trying to maintain the country’s unsustainable trade surplus. The Communist leadership’s weapons of repression and censorship cannot hide the gradual emergence of a middle class that wants the incentives of a more market-based economy.
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Yet wide-ranging crackdowns on companies such as Alibaba and Tencent (SEHK:700) have prompted Chinese companies to pander to the authorities rather than take risks on innovating. Already China is lagging the West in the development of artificial intelligence, and Western companies will be rather more reluctant than in the past to hand over their intellectual property. Something has to give.
Other sectors to cause concern are property, where lockdowns have added to a wider weakness, and banking, which will take a hit if there are bankruptcies in the property market.
While China has shown a cavalier attitude towards the West and also towards other major Pacific neighbours, it has pressed ahead with its Belt and Road initiative to win hearts and minds in less developed countries, especially in Africa. These are markets that offer China the opportunity to extend its power and influence but lack the consumer spending power that will fuel the Chinese economy.
Xi now has his eyes on cosying up to Saudi Arabia, with hopes of selling arms and technology to the Gulf states. He may find some common ground with a group of authoritarian states. This could be his best chance to put the Covid-19 troubles behind him.
Rodney Hobson is a freelance contributor and not a direct employee of interactive investor.
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