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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.)

Chart 1: Vaccinated* Share of Population (%, latest)

chart001-63.png

Sources: CEIC, NHC Press Conference, Capital Economics

Chart 2: Daily COVID-19 Deaths Per Million (7d ave.)

chart002-45.png

Sources: OurWorldInData, Capital Economics

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.


Data Previews

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

Forecasts

Time (China)

Previous

Consensus

Capital Economics

Exports (USD, % y/y)

-

(+20.9%)

(+15.7%)

(+10.8%)

Imports (USD, % y/y)

-

(+19.5%)

(+16.0%)

(+19.7%)

Trade Balance (USD)

-

+95bn

+50bn

+37bn

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.

Chart 3: Chinese Exports ($bn, Seas. Adj.)

chart003-23.png

Sources: CEIC, Capital Economics

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

Forecasts

Time (China)

Previous

Consensus

Capital Economics

Foreign Exchange Reserves

-

$3,222bn

$3,230bn

$3,225bn

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.

Chart 4: Net FX Purchases (USD bn)

chart004-22.png

Sources: CEIC, Capital Economics

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

Forecasts

Time (China)

Previous

Consensus

Capital Economics

CPI (% y/y)

09.30

(+0.9%)

(+0.8%)

(+0.7%)

PPI (% y/y)

09.30

(+9.1%)

(+8.6%)

(+8.9%)

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.

Chart 5: Producer Prices & PMI Output Prices

chart005-9.png

Sources: CEIC, Capital Economics

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

Forecasts

Time (China)

Previous

Consensus

Capital Economics

Net New Bank Loans (RMB)

-

+3,980bn

+1,400bn

+1,570bn

M2 (% y/y)

-

(+9.8%)

(+9.5%)

(+9.7%)

Aggregate Financing “AFRE” (RMB)

-

+6,173bn

+2,200bn

+2,200bn

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.

Chart 6: Direct Financing (outstanding, % y/y)

chart006-8.png

Sources: CEIC, WIND, Bloomberg, Capital Economics


Economic Diary & Forecasts

Upcoming Events and Data Releases

Date

Country

Release/Indicator/Event

Time (China)

Previous*

Median*

CE Forecasts*

March

Sat 5th

image007-1.png

Chn

Start of National People’s Congress (including the presentation of government work reports and the budget)

-

-

-

-

Mon 7th

image007-1.png

Chn

Foreign Exchange Reserves (Feb., USD)

-

+3222bn

+3230bn

+3225bn

image007-1.png

Chn

Trade Balance (Feb., USD, ytd)

-

+94.5bn

+97.3bn

+37.0bn

image007-1.png

Chn

Exports (Feb., ytd y/y)

-

(+20.9%)

(+15.7%)

(+10.8%)

image007-1.png

Chn

Imports (Feb., ytd y/y)

-

(+19.5%)

(+16.8%)

(+19.7%)

Wed 9th

image007-1.png

Chn

Producer Prices (Feb.)

(09.30)

(+9.1%)

(+8.6%)

(+8.9%)

image007-1.png

Chn

Consumer Prices (Feb.)

(09.30)

(+0.9%)

(+0.8%)

(+0.7%)

Also expected during this period:

9th – 15th

image007-1.png

Chn

Aggregate Financing “AFRE” (Feb., RMB)

-

+6172bn

+2200bn

+2200bn

9th – 15th

image007-1.png

Chn

Net New Lending (Feb., RMB)

-

+3980bn

+1400bn

+1570bn

9th – 15th

image007-1.png

Chn

M2 Money Supply (Feb.)

-

(+9.8%)

(+9.5%)

(+9.7%)

11th – 18th

image007-1.png

Chn

Foreign Direct Investment (Feb., RMB)

-

(+11.6%)

-

-

Selected future data releases and events:

March

Tue 15th

image007-1.png

Chn

1-Year Medium-Term Lending Facility (MLF) Auction (Mar.)

image007-1.png

Chn

Spending and Activity Data (Feb.)

Wed 16th

image007-1.png

Chn

Home Prices (70 Cities) (Feb.)

Thu 17th

image008-1.png

HK

Unemployment Rate (Feb.)

Fri 18th

image007-1.png

Chn

Foreign Exchange Net Settlement and Receipts (Feb., RMB)

Also expected during this period:

TBC

image007-1.png

Chn

Vehicle Sales (Feb.)

TBC

image007-1.png

Chn

PBOC Depository Corp. Survey (Mar.)

TBC

image007-1.png

Chn

PBOC Balance Sheet Data (Mar.)

Main Economic & Market Forecasts

%q/q annualised (%y/y), unless stated

Latest

Q1 2022

Q2 2022

Q3 2022

Q4 2022

Q1 2023

2021

2022f

2023f

Official GDP

(+4.0)*

(+4.8)

(+4.6)

(+5.1)

(+4.7)

(+4.8)

(+8.0)

(+5.0)

(+5.0)

GDP (CE CAP-derived estimates)

(-1.8)*

(-1.8)

(-2.4)

(+6.1)

(+8.3)

(+7.5)

(+8.2)

(+3.0)

(+4.5)

Consumer Prices

(+0.9)***

(+1.7)

(+1.6)

(+1.7)

(+1.2)

(+1.4)

(+0.9)

(+1.6)

(+1.4)

Producer Prices

(+9.1)***

(+10.2)

(+8.2)

(+5.1)

(+1.1)

(-1.0)

(+8.1)

(+6.5)

(-2.0)

Broad Credit (AFRE)

(+10.5)***

(+10.6)

(+11.0)

(+11.2)

(+11.1)

(+10.7)

(+10.3)

(+11.1)

(+9.7)

Exports (US$)

(+20.9)**

(+19.0)

(+11.0)

(+3.0)

(-4.5)

(-7.0)

(+29.9)

(+6.0)

(-6.0)

Imports (US$)

(+19.5)**

(+23.8)

(+9.5)

(-1.3)

(-2.5)

(-5.0)

(+30.1)

(+7.5)

(-6.0)

RMB/$

6.32

6.40

6.50

6.60

6.70

6.75

6.37

6.70

6.90

7-day PBOC reverse repo %

2.10

2.00

1.90

1.90

1.90

1.90

2.20

1.90

1.90

1-year Loan Prime Rate (LPR) %

3.70

3.60

3.50

3.50

3.50

3.50

3.80

3.50

3.50

1-year MLF Rate %

2.85

2.75

2.65

2.65

2.65

2.65

2.95

2.65

2.65

10-year Government Bond Yield %

2.84

2.70

2.60

2.60

2.60

2.5

2.78

2.60

2.50

RRR (major banks) %

11.5

11.0

10.5

10.5

10.5

10.5

11.5

10.5

10.5

CSI 300 Index

4,512

4,650

4,750

4,850

4,950

4,965

4,940

4,950

5,000

Hong Kong GDP

(+4.8)*

(-5.3)

(-7.9)

(-2.1)

(+2.3)

(+7.9)

(+6.4)

(-3.0)

(+7.0)

Hang Seng Index

21,956

22,500

23,800

24,200

24,250

24,350

23,398

24,250

24,750

Sources: Bloomberg, CEIC, Capital Economics *Q4; **Dec.; ***Jan.; End of period


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