China’s economy has faced a challenging start to 2022. Although GDP grew by 4.8 percent in the three months to March, up from 4 percent in the final quarter of 2021, there are considerable downside pressures ahead. After strong growth in the first two months, March was a turning point. The unfolding economic fallout of the Ukraine war has brought new levels of geopolitical complexity and dampened prospects for global economic growth. Meanwhile, China is experiencing the largest Covid-19 outbreaks and lockdowns since the pandemic began, as the government sticks to its strict pandemic management policy.
Clearly, March brought very unpleasant headaches for China’s leadership, requiring urgent policy changes. With the upcoming 20th Party Congress in the fall the government is looking for stronger stimulus measures to support economic growth.
China has been less affected than many other countries by the skyrocketing energy and food prices sparked by Russia’s war in Ukraine. It has a high degree of self-sufficiency in grain and benefits from the mitigating effects of state-owned enterprises in the energy sector. But the longer the war drags on, the more China’s economy will be affected. After rising prices for key commodity imports, the most immediate threat comes from falling exports. Soaring inflation is denting consumers’ purchasing power in key export destinations. China has enjoyed nearly two years of thriving exports propping up GDP growth, something that seems likely to end. If so, manufacturing activity will be negatively affected, and already struggling small and medium enterprises (SMEs) will suffer the most.
The government’s attempt to shift from the “zero Covid” policy to “dynamic zero Covid” has been far from smooth amid a record number of new cases. Rigorous pandemic management policies have hit China’s industrial heartland, with lockdowns in Shanghai, Shenzhen, and Jilin in the northeast. Manufacturing supply chains have been disrupted and prospects for a recovery in consumption look dismal. Consumption was already the weak spot during the economic recovery last year. Now, households are again increasing their savings to guard against uncertain times.
Nonetheless, China’s government has set its GDP growth target at “around” 5.5 percent. The target looks highly ambitious as exports and consumption will fail to support growth. However, the reason is straightforward: growth needs to reach this target to ensure labor market stability. In 2022, China’s labor market will need to absorb a record 10.8 million university graduates.
The government will accelerate stimulus measures in order to reach its GDP growth target. It is already easing up on regulatory tightening in the real estate and tech sectors. The shift towards more expansive fiscal and monetary policy is set to accelerate to shore up investment. But as private companies seem unlikely to invest, already highly leveraged local governments and state-owned enterprise are likely to do the heavy lifting, which will erode long term efforts to reduce debt levels and underlying financial risks.