OECD Economic Outlook, Volume 2022 Issue 2

China

Economic growth will slow to 3.3% in 2022 and rebound to 4.6% in 2023 and 4.1% in 2024. The emergence of the omicron variant has led to recurring waves of lockdowns in 2022, disrupting economic activity. Amid mounting headwinds, growth will be held up by infrastructure investment and supportive measures that moderate the correction in the real estate sector. A pick-up in precautionary savings, spurred by low consumer confidence coupled with inadequate social protection, is holding back a rebalancing of demand towards consumption. Export growth will remain low amid weaker global growth prospects before picking up in 2024. Despite recent fresh food price rises, consumer price inflation will remain benign due to the current measures to manage energy and food prices.

Monetary policy has become more supportive with a series of interest rate and reserve requirement rate cuts. More stringent implementation of credit quotas for presold housing and the lower providence fund lending rate for first homebuyers will mitigate the downturn in the property sector. Fiscal policy will become more supportive with a number of new measures. Tax and various user charge deductions and exemptions for targeted groups will continue to provide some support. A strengthened social safety net would invigorate household consumption.

Disruptions due to pandemic-related lockdowns persist

GDP growth picked up in the third quarter of 2022 to 3.9% year-on-year, following 0.4% year‑on‑year growth in the second quarter. The rebound partly reflects the easing of COVID‑19‑related lockdowns as cases fell. Just over 90% of the population is vaccinated by domestically-made vaccines, but these are considered less effective than the ones used in OECD countries. Moreover, a high share of the elderly is unvaccinated. A new COVID-19 management system based on the level of risk has been introduced since July as a transitory measure following hard lockdowns, which allows a faster resumption of activities. Testing requirements for new arrivals are being introduced in a number of cities, erecting internal barriers to economic activities. The restrictions continue to affect the services sector and consumption significantly. Investment growth is firming as infrastructure investment is picking up and new support measures contain the contraction of real estate investment. Stringent regulations governing real estate investment, including the so-called “three red lines” related to financial ratios, caps on real estate lending by bank type and stringent loan-to-value ratios, remain in place.

China 1

Source: CEIC.

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China: Demand, output and prices

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The impact of Russia’s war of aggression against Ukraine has been limited as neither Ukraine nor Russia is an important economic partner for China. Moreover, China is relatively well insulated from global food and energy market shocks due to the structure of consumption, with a large share of food that has limited import content. China’s large grain reserves and export restrictions in the form of quotas will continue to mitigate the impact of rising global grain prices on domestic inflation and reduce the risk of shortages. However, lockdown-induced supply-side constraints on fresh food have started to push CPI inflation higher, to 2.8% year‑on‑year in September. Replacing part of crude oil imports by discounted Urals oil from Russia is also helping to contain inflationary pressure and LNG reserves are being refilled from Russian sources.

China 2

Source: CEIC; and OECD Economic Outlook 112 database.

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Monetary and fiscal policy have become more supportive

Monetary policy has become more supportive and is assumed to continue providing the necessary liquidity. The required reserves ratio and the benchmark lending rate have been cut twice since late 2021, contributing to a widening interest rate differential with the United States and leading to capital outflows and a depreciation of the currency. To lower lending rates without cutting the benchmark rate and increasing depreciation pressures, major state lenders cut the deposit rate in a coordinated fashion in September for the first time since 2015. Credit supply is ample, but demand is held back by the impacts of the property downturn and zero-COVID-19 policies. The wealth effect of falling property prices is limited, as households tend to hold real estate for longer periods and first-time buyers are benefiting from lower provident fund mortgage lending rates, but heightened uncertainty is boosting precautionary savings and encouraging deleveraging. Enterprise loan demand is constrained by weaker collateral values, weak global economic prospects, tax relief measures, and lockdown-related supply-side disruptions. Corporate debt has stabilised at a very high level of over 150% of GDP. Deleveraging needs to continue and orderly bond defaults would help sharpen risk pricing and gradually remove implicit guarantees.

Fiscal policy will continue to provide support in the form of cuts and deferrals of taxes and charges and spending of reserve funds. Some of the proceeds of special local bonds may be spent only in 2023. A wide range of additional policies are being implemented, including ones outside the public budget. Overall, the measures are worth 1-2% of GDP. Development banks are providing funds financed by bonds to meet own capital requirements in projects, as a lack of funds has appeared to constrain the rolling out of infrastructure projects. Central government-controlled electricity companies will borrow more to fund electricity generation capacity. Sizeable interest subsidies are available to support relending for manufacturing, social services, small and medium-sized companies and individual businesses. The recent requirement for local government investment vehicles to secure the budget prior to carrying out infrastructure projects helps contain contingent liabilities and has constrained their activities.

Activity will recover only slowly

GDP growth will gradually move back up to its underlying pace, which is slowing. Infrastructure investment will pick up, partly offsetting weaker real estate investment. A further rise in corporate defaults will improve risk pricing, but may adversely affect banks, trust companies, as well as other private and institutional investors. Further virus outbreaks and restrictions are likely, constraining consumption, though to a lesser extent than in early 2022 assuming case numbers decline. A stable supply of energy and grains will play a key role in containing price increases, helping headline inflation remain benign.

The sanitary situation remains a key downside risk as outbreaks continue and there are no signs of a full abandonment of zero-COVID-19 policies. Continued defaults and disorderly deleveraging in the overstretched property sector may trigger failures of smaller banks and shadow banking institutions. By contrast, relaxing prudential measures and encouraging investment in real estate may fuel the bubble and cause greater disruptions further down the road.

Structural reforms are needed to reinvigorate the economy

Fundamental reforms to strengthen the social safety net would help to reduce precautionary savings and rebalance demand from investment to consumption. Pension and unemployment insurance coverage should be extended to all. The list of treatments and medicines covered by health insurance should be widened. Levelling the playing field would support private sector investment, which has weakened with the property downturn and has less been able to benefit from infrastructure projects. Reforms to enhance competition would sustain the economic recovery from the pandemic. Administrative monopolies, often with exclusive rights to provide certain goods and services, should be dismantled. Recent measures aiming at creating a single domestic market are a welcome step. Stronger consumer protection could boost competitive pressures. Raising vaccination rates and increasing their effectiveness would reduce disruptions to economic activity. As renewables production has become sustainable and subsidies are being phased out, more funds should be channeled to support the transition to zero net emissions. Small‑scale renewables production could be encouraged by allowing producers to sell any excess electricity through the grid. The relocation of energy‑intensive industries to regions with ample renewable energy should accelerate. Investment in coal, even if clean, will likely lead to stranded assets, suggesting that investment in new coal‑fired power plants should be halted.