This week we look at China and try to grapple with the zero Covid policy and what that means for markets. A story that remains especially important as China is central to our economic fortunes and the world; in terms of growth and the implications on inflation.
As with many things China-related, it may be challenging to determine the outcomes and the decision-making rationale for policymakers. Especially given the tight reign on information and the existence of a rumour mill unparalleled to anything in the west. However, this likely drove the markets higher in early November with a US $450 Billion rally.
The basis for it?
Xi Jinping delivered a 2-hour speech at the 20th Peoples Congress. Rumours and the grasping of straws for signs of hope helped the market significantly rise.
When it comes to China, the markets tend to dissect any official words with more tenacity than the Fed minutes. As though this wasn't enough, we also had unofficial leaks, including screenshots from unknown sources, that easing of Covid restrictions discussions were ongoing.
In addition, Chancellor Olaf Scholz's visit to Beijing following "Emperor" Xi's coronation indicated that access to the BioNTech Pfizer vaccine has been secured.
It didn't matter to the market that the vaccine was limited in its rollout, with no signs that it would be preferred over local alternatives. For investors, any news is good news, and then the rumour mill continued on its trajectory that we will have an easing on 23 March (where this news came from is quite beyond us).
What do we know so far?
The zero-Covid policy continues to have primacy. Hopes of stimulus and an overall property bailout that stoked a rally in benchmark spot iron ore seem to have been misplaced. The only change so far has been the fast-tracking of a 1 Trillion Yuan package earmarked earlier in the year (including 300 Billion for infrastructure projects). Provincial party bosses and the state apparatus appear intent on outdoing each other in their projection of loyalty to Xi's policies. This has given Xi's power (including stacking the central commission with personal loyalists) a boost.
When does this end?
At the time of writing, we don't quite know. And bizarrely, we expect that on a balance of probabilities, neither do the parties formulating the policy. At this point, lockdowns are intermittent. The party seems to be putting out fires as they come, having about as much logic to it as Mao's cultural revolution (though arguably fewer fatalities this time). It may just be that the powers that be have the below rationalisations to balance out:
1. Save Face - The problem for Beijing is this. The local vaccines, namely Sinopharm and Coronavac, have an abysmal efficacy record regarding immunity (it rapidly declines after the initial dosage). Thus, without lockdowns, authorities would have to buy workable solutions from Western companies if they wished to minimise human collateral (i.e. China would have a second wave several times larger than any seen to date given the lack of herd immunity). Their solution so far seems to be - lock it down indefinitely.
2. Hope for a local vaccine - Most global majors, including Moderna, have outright refused technology transfer regarding the mRNA vaccine. This has meant that local companies are racing to develop alternatives with prodding from Beijing. However, the policy continues to be questionable, given that the plants for future vaccines are likely to be ready before an available product. For example, an affiliate of the state-owned drugmaker Sinopharm has completed an mRNA vaccine plant with a 2 billion dose manufacturing capacity, with the only problem being that there is nothing to manufacture.
3. Stability at all costs - This is where the putting out of fires policy is most apparent. Despite the importance of zero-Covid policy, provincial party bosses are still incentivised to print some numbers, especially regarding growth. This means that on a regional or local level, officials are falling over each other in terms of how draconian their responses to any outbreaks are. All the while, gaming the system to ascertain lucrative handouts from state-owned banks and building out infrastructure projects to maintain some semblance of business as usual.
What does this mean?
The balancing out act of the three imperatives above means that official party policy is no policy at all - a spectacular case of "talking but not saying anything" is what is in play when one hears or reads official communications.
The nature of the system is nevertheless such that we shall continue to see the status quo maintained for the foreseeable future. Churchill's quote on the Americans doing the right thing after exhausting all others is just as apt for Beijing. The silver lining remains clear; the longer this goes on, the bigger the cheque that has to be written out when the reopening does occur.
So far, the economy has remained nominally resilient (nominal because we shall never quite know the numbers or underlying reality), but we see substantial scarring and exacerbation of pre-existing issues. For example, debt and non-financial liabilities for companies owned by local governments will hit close to 51% of GDP this year. Moreover, based on current expenditure, Beijing will incur an additional $13.4 Trillion in loans this year while the debt-ridden real estate sector (accounting for 29% of GDP) continues to see massive levels of distress. On the latter front, at the time of writing, homebuyers with over 300 unfinished projects are refusing to pay their mortgages.
The shorter to medium-term outlook is hard to fathom, and the rumour mill will drive markets (commodities and securities). The longer term for us is quite a lot easier to see. In our view, there will be stimulus, and Beijing's postponing the inevitable will only drive up the price tag when it comes to fruition.
While it is true that the politburo has all but gotten rid of the previously touted 5.5% growth target, with even official rates likely to be printed at 3.9%. What we see however is a shortfall makeup at some point in the future. That is, we make the call that the lower the number over the next 12 months, the higher the stimulus cheque in the 12 thereafter. The long-term target remains in place (the "trying our best" rhetoric of more recent times is a way again to save face as usual).
Markets & Commentary
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