Is Covid China’s Brexit?
China is having a shocker of a year. Growth has stalled, deflation is back and global firms are moving production elsewhere as they de-risk from China to boost supply-chain resiliency. FDI is down sharply and exports are sinking. Just as Brexit reshaped the UK’s relationship with the world, has Covid done the same for China?
The idea isn’t so far-fetched. Extricating the UK from the clutches of a chronically under-performing and directionless European Union (EU) in 2016 made sense to a slim majority of UK voters. In turn, a large minority were appalled by what was in their eyes a collective act of self-harm by a global-facing country reliant on foreign capital and labour.
Both sides engaged in a fair amount of misdirection and fearmongering before and after the poll. Those pushing the leave vote rolled out a garish red bus emblazoned with a pledge to use the money raised by leaving the bloc to fund the UK’s National Health Service (NHS). Advocates of the status quo warned that leaving the warm embrace of the prelapsarian paradise would cause huge job losses and crater the economy. Neither, of course, happened.
Brexit was always going to be a multi-year and even a multi-decade project. In our deeply interconnected world, any notable departure from financial, political and trading norms – anything that in effect creates a new form of polity – will always wreak long-term change.
The UK is only now starting to feel the effects of those chill winds. The UK has been left to patrol its own seas, to resolve issues ranging from immigration to climate change, to re-forge a global diplomatic identity and to find regulatory common ground with the single European market, not to mention the likes of the US and China.
At times the process has been painful to watch. It may well get worse before it gets better. Or it may get better before it gets worse. Either way, it’s a stark reminder of the perils of taking a leap in the dark. You don’t know when, or indeed if, your feet will again touch the ground.
And to China.
Eighteen months ago, any observer of Asia’s largest economy knew two things about China and Covid. First, that the virus began in the central city of Wuhan – though exactly how, we may never know. And second that Beijing was having, as things go, a pretty good pandemic.
In hindsight, 2020 and 2021 were halcyon years for mainland policymakers, who watched as export revenues rolled in. But as 2022 wore on, problems began to mount. When Shanghai identified a handful of positive cases of the Omicron strain in March, officials locked down the city. The financial hub did not reopen until May.
That hit GDP. Output expanded by just 3% last year, the second-slowest rate of growth since the 1970s. This year has fared little better.
Policymakers tipped China’s economy to hit the ground running. And to be sure, first-quarter data wasn’t bad. But every piece of financial and economic news to emerge from the mainland since late spring has been miserable. Beijing has even resorted to accusing Western media of revelling in its infirmity and exacerbating its problems.
It’s clear that beyond closing its borders and testing like crazy, it didn’t really have a plan to tackle Covid. The West suffered two bad years and emerged a little more battle-hardened. China’s approach – to shut the world out and hope for the best – just delayed the inevitable.
“The whole of 2022 and the early part of 2023 was traumatic,” says Jerry Wu, manager of London-based investment manager Polar Capital’s £18 million ($22.9 million) China Stars Fund. “Recovering from that takes time.”
China’s problem now is that it has been unmasked. Its financial woes are in danger of becoming endemic, even chronic. The property crisis continues to deepen: on August 17, real-estate developer Evergrande sought Chapter 15 bankruptcy protection in New York. Revenues from land sales sank 20% year-on-year in the first half.
Few expect the country to hit its moderate official 5% growth target – ‘moderate’ because of last year’s low base number – in 2023. Exports and imports are down sharply. Deflation is back. Local officials are borrowing just to pay the salaries of civil servants. Youth unemployment data is so bad, China no longer releases it.
Meanwhile, the $2.9 trillion trust sector is emerging as yet another potential flashpoint. In August, the private wealth leader Zhongzhi Enterprise, which manages Rmb1 trillion ($138 billion) in assets, halted payments on dozens of high-yield investment products.
Policymakers are stuck. On Tuesday, the central bank cut its one-year loan prime rate to 3.45% from 3.55%. Investors shrugged: the Shanghai composite index is down 1.22% in the year to August 23; compare that to the Nasdaq composite, which is up more than 32%.
Just as the UK’s struggle to boost productivity and balance its books predates Brexit, not all of China’s current malaise can be placed squarely at Covid’s feet
Overseas funds sold $10.7 billion-worth of mainland equities in a 13-day period to the end of August 23. Stocks most heavily targeted by investors span electric vehicles, pharmaceuticals, renewables and consumer goods – underlining the breadth and depth of negative sentiment.
There is more Beijing can do – it has plenty of cash lying around.
It could unveil a huge stimulus spree, as it did in the global financial crisis, an act that staved off recession but borrowed from the future. Or it could seek to revive its capital markets by encouraging private equity firms to spin off and list assets in Shanghai and Shenzhen.
But what if investors, having previously been burned by president Xi Jinping’s disdain for private capital, shrug a second time? Besides, officials are trying to move away from an old growth model – based on favouring exports over retail consumption – that no longer works, not to mention weaning local officials and firms off their dependence on state bailouts.
Neither is there a clear and non-painful solution to its property crisis. China has tried three times to stimulate the property sector, but, notes Wu: “Each time it has come back to haunt them in a bigger way.”
So, policymakers are stuck. “It’s a case of a lack of confidence and it’s a vicious cycle,” he adds. “A lack of consumer confidence leaches into business confidence, [which saps the] willingness to expand and employ, which leaches back into consumer confidence.”
How does this loop back to the UK’s decision to leave the EU?
Clearly, autocratic China does not vote for anything, not least a global pandemic, but there are parallels in how the two events are hitting and hurting the respective nations.
The various complex interplays and impacts from Brexit took time to materialize – as many in Brussels warned would be the case. Those have only been exacerbated by Covid. The same is likely to happen with China and Covid. That the pandemic started there is, in a strange way, immaterial. What matters more is what happened next.
First, Beijing lectured the world on the structural benefits of its one-party system – a strategy that looks ever-more misguided today. Second, the decision to bolt its doors in 2020 kept the virus out but also stopped global investors and multinationals from ploughing capital into the country, opening new factories and assessing local teams.
And third, the people running those companies started to look to de-risk from China and boost resiliency in their supply chains by moving factories – and therefore capital investment and jobs – to open markets less hostile to private capital, such as Mexico or Vietnam.
That doesn’t mean global firms are fleeing the mainland. Far from it: many are shoring up their local presence. But it does mean an extended era in which China acted as the workshop to the world is in effect over.
All of which matters deeply. Shortly after becoming leader in 2012, Xi hailed the “great rejuvenation of the Chinese nation”. But this was predicated then – much as it is now and just as it was in the 1980s – on two main factors: sucking in foreign capital to produce goods for export.
Now, the reliability of both those tenets is being called into question. Capital is flowing out the country at exactly the wrong time, or it is not arriving at all.
Monthly exports totalled $281.8 billion in July, down 14.5% year-on-year and far below the peak of $340 billion in December 2021. Direct investment liabilities, a key measure of foreign direct investment (FDI), was just $4.9 billion in the second quarter of 2023, down 87% year-on-year and the worst quarterly number since 1998.
Just as the UK’s struggle to boost productivity and balance its books predates Brexit, not all of China’s current malaise can be placed squarely at Covid’s feet.
But both are seismic events that are reshaping how the outside world views the two nations, not to mention how it engages and trades with them. The impacts are only now starting to become clear – and they will continue to develop, and to resonate, for decades to come.