Hong Kong underlines risks of zero-COVID opening

“Experimental opening” will be limited in scope

Media reports over the past few days suggest that officials have begun discussing ways to pivot away from a zero-COVID strategy. We’ve argued for some time that China will transition toward living with the virus but only once the leadership is confident that the health costs would be manageable.

In the same reports, government sources have signalled that there won’t be any wholesale change to COVID policy before next spring. And although there is talk of experimental opening measures in some cities as early as this summer, it won’t be possible to meaningfully move away from zero-COVID in some parts of the country but not others unless they are sealed off from one another.

Furthermore, since the virus spreads exponentially, officials have no choice but to continue to quash outbreaks: there is no stable middle ground, especially with the transmissible Omicron variant. Hong Kong is a case in point – tighter social distancing measures didn’t stop caseloads surging.

As such, until there is a fundamental shift in strategy, any experimental opening measures will need to be very limited in scope or else they will risk seeding large-scale outbreaks before the government is ready to start living with the virus.

Officials have good reasons to want to stick with zero-COVID. Although China’s overall vaccination rate is high, over 40% of residents 80 and above have not received a single dose. (See Chart 1.) Studies suggest the Omicron case fatality rate among unvaccinated individuals in this age group is around 20%: millions of elderly would die if the government allowed the virus to spread now.

Once again, Hong Kong offers a warning. It also has a low vaccination rate among the elderly which is now leading to immense strain on its health care system. Over the past week, there have been more deaths in the city than during the peaks in the US and EU, after adjusting for population size. (See Chart 2.)

Unless Omicron is supplanted by a new variant that poses less of a threat, we doubt China’s leadership will abandon the zero-COVID approach until the vaccination rate among the elderly is above 80% and it has rolled out mRNA booster shots. Since China remains unwilling to use foreign jabs this means waiting for stage 3 trials of its homegrown mRNA vaccine to be completed and production ramped up. Zero-COVID will continue to hold back China’s struggling service sector for some time.

The week ahead

The war in Ukraine will remain the key focus for many. Links to all our work on the crisis, including the impact on China’s economy, and China’s role with respect to sanctions are here. But for China watchers, the annual session of National People’s Congress that kicks off tomorrow will draw attention too. We previewed the meeting here. We also get data on trade, FX reserves, inflation and credit.

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Data Previews

Trade (Jan. & Feb.) Mon. 7^th Mar.

Trade softens at the start of the year

It’s almost certain that export growth slowed in y/y terms in January and February. Outbound shipments jumped at the start of 2021 and constraints on shipping capacity mean this is very unlikely to be repeated this year.

More important is what happened to the level of trade compared with December. Data from China’s trading partners suggest that its exports probably declined in January amid supply-side disruptions due to virus outbreaks (See Chart 3.) Although February’s PMIs point to some modest improvement last month, January’s weakness does not appear to have been fully reversed.

Imports are likely to have softened too. Admittedly, rising commodity prices will have nudged up import prices. But high frequency data on land sales and steel output suggest that Chinese import-intensive construction sector continued to cool, which will have weighed on import volumes.

FX Reserves (Feb.) Mon. 7^th Mar.

PBOC dissatisfied at currency’s strength

Although the PBOC has largely stuck to indirect intervention, it has added small amounts to its FX reserves recently. (See Chart 4.) These were the largest purchases since 2015 and are a signal of its discomfort with the renminbi’s recent strength. They also coincided with hikes to foreign exchange reserve requirements for financial institutions.

Despite these moves, the currency has taken another leg up recently, which probably led to further PBOC intervention. Direct purchases likely remained small to avoid triggering the ire of its trading partners amid already elevated tensions. But state firms may have stepped up intervention on the PBOC’s behalf.

Other things equal, valuation effects should have pulled up the value of the reserves last month (by around $8bn on our estimates). Our forecast assumes that FX purchases will have largely balanced this out.

CPI, PPI (Feb.) Wed. 9^th Mar.

Price rises accelerate on eve of war with Ukraine

Although it won't be visible on the headline y/y figures due to base effects, rising commodity prices and supply shortages will have pushed up inflation in February.

Admittedly, high frequency data point to a further decline in foods prices last month as government support continued to shore up the pig supply. But caps on retail prices for fuel were adjusted upward in mid-February. And core inflation probably ticked up in m/m terms amid slightly higher prices of consumer durables due to supply shortages.

Meanwhile, the rise in the output price indices of the PMIs signalled that factory-gate price pressures were already building even prior to the surge in global commodity prices over the past week due to the war in Ukraine. (See Chart 5.) That surge will only start to show up in the Chinese inflation data for March onwards.

Net New Bank Loans, M2, AFRE (Feb.) 9^th – 15^th Mar.

A further pick-up in credit growth

Credit growth continued to rebound at the start of the year thanks to a more supportive policy stance. We think it was still trending upward in February.

There will have been a huge step down in the net increases of both bank loans and aggregate financing (AFRE), the PBOC’s measure of broad credit, in February from the highs in January. That’s the usual seasonal pattern as loan quotas are refreshed at the turn of the year. More importantly, we think y/y growth in outstanding loans and broad credit growth edged up.

Since the start of the year, more than 50 cities have relaxed property controls, driving a rebound in home sales. This will have boosted mortgage lending. Meanwhile, our bottom-up estimates point to faster government and corporate bond issuance. (See Chart 6.) We have less real-time data on shadow credit, but we suspect that the contraction probably eased on that front.

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Economic Diary & Forecasts

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Julian Evans-Pritchard, Senior China Economist, julian.evans-pritchard@capitaleconomics.com
Sheana Yue, China Economist, sheana.yue@capitaleconomics.com