To say that China is ill-prepared for President Xi Jinping’s recent abrupt departure from his zero-COVID policy would be a gross understatement. With a large proportion of the population under-vaccinated, COVID is spreading like wildfire across the country. More than half of the passengers on a flight from China to Italy tested positive this week.
Leaked notes from official Chinese estimates show as many as 250 million people may have been infected with the virus in the past 20 days. This is now leading to widespread absenteeism from the workplace and a sharp drop in consumer and investor confidence in the economy.
There is never a good time for the COVID chaos to hit China, the world’s second largest economy and until recently the world’s main economic engine. But it’s a particularly bad time for such a shock.
China’s economy was already in a weakened state thanks to the zero-COVID policy and the bursting of its outsize real estate and credit market bubbles. China’s economic growth for 2022 is likely to have been around 2.75%, according to the World Bank – half of the government’s growth target of 5.5%.
Chinese economic growth for 2022 is likely to have been only around 2.75%.`
Beijing’s new economic shock comes as the rest of the world economy heads into recession as central banks slam on the monetary brakes to regain control of multi-decade high inflation.
With the virus expected to spread exponentially in late January, when Chinese workers head home to celebrate the Lunar New Year, a strong response from Chinese politicians is expected to prevent a major economic downturn. That seems particularly the case given China’s ongoing housing meltdown and bleak export prospects at a time of global economic weakness.
This makes it all too likely that the Federal Reserve has turned on monetary policy in much the same way it did in 2020 and the US government, in response to the COVID-induced economic recession, has provided the Chinese with their biggest peacetime fiscal stimulus on record The government will do the same in response to its new COVID economic crisis. Lower interest rates could further weaken the Chinese currency and encourage Chinese capital flight.
The good news for the rest of the global economy is that China, the world’s largest consumer of internationally traded commodities, its renewed COVID outbreak could result in lower commodity prices in general and lower international oil prices in particular.
Another way the Chinese pandemic could ease global inflationary pressures is that it could result in lower Chinese export prices. This would be particularly the case if China’s COVID-induced slowdown were to result in lower domestic prices and a weaker currency.
The bad news is that China’s renewed economic problems related to COVID could deal a severe blow to the already ailing global economy in a number of ways. As Apple recently warned, China’s economic woes could lead to renewed supply chain disruptions that could limit production. Meanwhile, reduced Chinese import demand could be very problematic, particularly for China’s Asian trading partners, while lower international commodity prices could accelerate the pace of emerging market defaults.
Leaked notes from official Chinese estimates show as many as 250 million people may have been infected with the virus in the past 20 days. `
In a time of global financial market weakness, the last thing we need is another pillar of the global economy. In the context of rising interest rates around the world to curb inflation, such a decline could put further pressure on global equity prices and put additional pressure on the global credit market. Yet that may be exactly what we may be facing in the first half of 2023 as China’s COVID crisis intensifies.
All of this underscores the need for a humble and nimble Federal Reserve. Should the global economy indeed continue to decline and should the pressure on US and global financial markets mount, the Fed should be ready to turn from its newfound monetary religion and start cutting interest rates.
Desmond Lachman, Senior Fellow of the American Enterprise Institute, was Associate Director in the International Monetary Fund’s Department of Policy Development and Review and Senior Emerging Markets Economic Strategist at Salomon Smith Barney.
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