Executive Summary
With new and expanding Covid-19 lockdowns in important industrial centers, China’s domestic economy will be slowed, requiring more fiscal and monetary stimulus to meet 2022 growth targets.
Despite Chinese government claims of its ‘limitless friendship’ with Russia, China continues its wait-and-see approach to the war in Ukraine, all the while attracting growing Western ire.
Concerns about international and domestic market volatility prior to China’s important Party Congress in the fall of 2022 mean Chinese leaders will emphasize economic and social stability.
Implications for International Business
Growing supply chain disruptions may result from intermittent lockdowns of manufacturing and export centers along China’s Eastern coast
Increased government efforts expected to drive market stability, particularly regarding domestic real estate and tech platforms as well as limited appetite for future deal-making with Russia.
State of Play The Challenges of “Dynamic Zero Covid” in China
China’s zero Covid strategy had kept infections to a minimum for two years, but the virus is resurging. While the main impact has been in Hong Kong, where a rapidly increasing death toll has led to social anxiety, the mainland is experiencing its largest wave since the original Wuhan outbreak. Most recently, the manufacturing and export hub Shenzhen was locked down, with potential knock-on effects on tech and other supply chains. China’s leaders will maintain the zero Covid policy until the Party Congress to ensure social stability. Meanwhile, reaching the targets set by the National People’s Congress (NPC) of 5.5% economic growth, 3% inflation, and the creation of 11 million new urban jobs, will require significant fiscal and monetary efforts. These include enhanced support for domestic semiconductor production, linked to longer-term efforts to promote technology innovation and self-sufficiency, as well as support for pandemic-hit sectors such as travel and tourism. The tax burden on SMEs is expected to decrease while spending on infrastructure aims to boost local revenues and employment.
Key Issues China’s Economy: Government-Induced Optimism Despite Strong Headwinds
In Q2 2022, China’s economy faces important headwinds. Besides the rise in Covid infections, these include real estate sector woes linked to a crackdown on lending to over-indebted firms like Evergrande and the economic and political fallout from Russia’s invasion of Ukraine, including rising prices for energy imports. To boost flagging real estate investment, the government vowed to hold off on proposed new property taxes while also reducing mortgage rates. The government has pledged to support green consumer technology for household appliances and electric vehicles, especially in rural areas, thus providing potential opportunities for foreign firms. Given the importance of foreign investors in key Covid-impacted manufacturing and export hubs in the Pearl River and Yangtze River deltas, local officials may prioritize revitalized commerce over strict regulatory enforcement. While some U.S. and European firms will continue to diversify parts of their sensitive technology supply chains to Southeast Asia, Europe and North America, there is little indication of wholesale supply chain relocation away from the mainland. Key for both Chinese and foreign firms was the government’s response to extreme volatility in China’s equity markets since the NPC’s conclusion in early March. The MSCI China Index was down nearly 30% for the year on 15 March, prompting Vice Premier Liu He to commit to support Chinese firms’ overseas IPO listings and “stabilize” the domestic market, including struggling technology platforms like Alibaba. Given increased uncertainty in international markets related to concerns about rising commodity prices and industrial supply chains, and the range of domestic economic challenges, China’s top economic officials are keen to minimize market volatility in the lead-up to the 20th Party Congress this fall.
The Challenges of China’s “limitless friendship” with Russia
In recent years China intensified its political and economic relationship with Russia for strategic reasons. The two president’s declaration during the Winter Olympics that the two states’ friendship “has no limits” as well as a US$118 billion oil and gas deal symbolized this trend. Yet, there are limits to the economic dimensions of this partnership that will constrain future cooperation in the wake of the war in Ukraine. Russia is a key energy partner for Beijing. However, China has been eager to diversify its energy sources and will have heightened awareness of Russia’s willingness to use its energy supplies as a tool of coercion. Despite China’s recent lifting of restrictions on Russian wheat exports, China imports less than 6% of its domestically consumed wheat. In addition, Chinese state-owned and private firms are strongly integrated into global supply chains and financial markets and are wary of being cut off from the SWIFT payments system if they run afoul of Western sanctions against Russia. Moreover, Chinese shipping, port and commodity firms have built up trade, investment and logistics ties with Ukraine, signing nearly US$7 billion in investment contracts in 2021. China will not only be leery of the war’s impact on its interests in Ukraine, but it will also be loath to see large swaths of the Belt and Road Initiative (BRI), which lie along Russia’s former or current sphere of influence in Central Asia and Eastern Europe, destabilized. As part of any ongoing withholding of criticism of Russia’s war in Ukraine, expect China to demand a large discount on Russian oil, gas and transshipment infrastructure. In the past, such demands have stymied the completion of Russian oil and gas pipelines to China and led to years of stalled negotiations on long-term contracts. Three scenarios in the evolving China-Russia relationship exist, out of which the first is the most likely: (1) despite continued anti-US and anti-NATO rhetoric, China bargains with the West over terms to moderate its support for Russia by demanding assurances that it will not be hit by sanctions nor targeted by an Asian version of NATO; (2) China reverses course on its support for Russia by playing an active role in mediating a peaceful settlement to the war; (3) China doubles down on its support for Russia’s invasion of Ukraine through increased military and economic assistance in return for Russian support for China’s claims to Taiwan. Xi Jinping will not use military means to reunify China and Taiwan in the near future. While strong US signals deter China from any provocative behavior in Taiwan, China will push to isolate Taiwan.