Can Xi Jinping Vanquish Covid Without Crushing China’s Economy?

Excepted from The Financial Times: If the world’s second-largest economy shows any sign of recovery from its Covid-induced slump, Wang Neng should be among the first to know.

But so far, he sees few indications of that. Like many small businesses in China, Wang’s cement mixing station in central Henan province has been hit hard by controversial lockdowns in dozens of cities ordered by President Xi Jinping to stamp out outbreaks of the Omicron variant.

Two months after Beijing promised vague measures to support the economy through the crisis — and despite Xi’s assurance of an “all out” infrastructure drive — Wang’s business is still struggling. “Looking at cement demand, there are few signs of an infrastructure pick-up,” he says. His station is running at only 20 per cent capacity and he has cut his fee for mixing cement by almost one-quarter from last year.

Wang’s business was already feeling pressure thanks to delayed payments from clients under stress further along the industrial chain. Even before the lockdowns hit, China’s economy had been badly affected by Xi’s “rectification” of the highly leveraged property sector, which is estimated to account for about one-third of the country’s economic output. Now, lockdowns imposed to salvage the president’s strict zero-Covid policy are making matters worse.

Xi’s administration has been here before. When Covid erupted out of central China in January 2020, Hubei province and its capital, Wuhan, were quickly locked down, with the rest of the country soon following. This time, the Japanese brokerage Nomura estimates that 41 cities with a combined population of 290mn and responsible for about 30 per cent of national economic output were under full or partial lockdowns as of May 10.

Yet there are crucial differences between the successful nationwide clampdowns at the start of the pandemic and the current series of rolling closures.

The 2020 measures were a relatively short, sharp shock. They coincided with the annual lunar new year holiday — China’s equivalent of the western Christmas and New Year break — during which many manufacturers routinely close for two or three weeks.

After an extended holiday, most of the country reopened within a month. Only Hubei and Wuhan were subjected to longer restrictions, and even these were lifted by late March. The impact on growth mirrored the brevity of the closures, with a 6.9 per cent year-on-year decline in first-quarter economic output, followed by a steadily accelerating recovery for the rest of the year.

By contrast, this spring’s lockdowns have been ad hoc and open-ended. They are ultimately controlled by low-level district or neighbourhood officials who respond — often brutally — to sometimes contradictory policy signals from the top of the Chinese Communist party.

Policy whiplash

At a May 5 meeting of the party’s most powerful body, the Politburo Standing Committee, Xi reiterated that he would not tolerate any let-up in the effort to eliminate all Covid cases from China. More worryingly for business owners such as Wang, he did so without his previous reassurances to “reconcile zero-Covid with growth” or to “minimise the impact of the pandemic on the economy”.

The effects could be severe. While China’s first-quarter data did not capture the worst of this spring’s lockdowns, a portent of things to come could be seen in a 3.5 per cent year-on-year fall in retail sales in March. Trade figures for April showed a marked slowdown in year-on-year export growth — 3.9 per cent compared to almost 15 per cent in March — yet even that was better than expected. Anecdotal evidence and surveys taken ahead of the release of key domestic data such as real estate and infrastructure investment on May 16 suggest a reckoning is coming. April vehicle sales fell 48 per cent year-on-year, according to industry data released on Wednesday.

“We won the battle to defend Wuhan,” Xi said at the meeting, according to state media. “We will certainly be able to win the battle to defend Shanghai.”

Since the start of the pandemic, such martial rhetoric has been a common refrain for Xi, who has embraced the crisis as an opportunity to prove himself a leader in the war on Covid. He added a warning: “Relaxing prevention and control measures will inevitably lead to large-scale infections, serious illnesses and death, and will seriously affect economic and social development.”

The admonition was a nod to his administration’s success in limiting official Covid deaths to just a few thousand — the US has suffered nearly 1mn. But it also highlights the government’s failure to vaccinate the elderly and other vulnerable people. A similar omission in Hong Kong led to a catastrophic outbreak there this year in which more than 9,100 people died, most of them elderly and unvaccinated. On May 9, researchers at Fudan University in Shanghai estimated a similar surge across China could kill as many as 1.6mn people in just three months.

The highest profile, and most controversial, Chinese lockdown has been the one imposed on all of Shanghai’s 26mn residents since April 1. Within hours of Xi’s comments on Covid control last week, police and enforcement officials in areas of Shanghai were imposing some of their harshest measures to date — including the forced transfer of all residents in a given building to centralised quarantine if even one of them tested positive. Many residents have complained of being unable to receive food deliveries.

Viral videos of overzealous enforcement have spread panic across the city. In one of them a police officer tells residents: “You can’t do what you want, like in America. This is China. So listen carefully [and] don’t ask me why, there is no why!”

Ever stricter measures adopted in Beijing over recent weeks have raised fears that the capital city could be subject to a full lockdown next. The main commercial district, Chaoyang, is already effectively closed for business and the Forbidden City is shutting indefinitely on Thursday. According to one popular Chinese Covid tracker service, more than 600 Beijing residential compounds were subject to moderate to severe restrictions on May 8 — up from 239 at the end of April.

James Zimmerman, a China lawyer at Perkins Coie who recently underwent a five-week quarantine ordeal to return to Beijing from the US, says 10 of his 30 colleagues in the capital have been caught in random residential lockdowns, with “more expected to get the call to stay at home at any time”.

“The uncertainty and unpredictability of the whiplash policy changes is a dismal experience,” he added. “It’s now a cat-and-mouse game to avoid crossing lines into areas on lockdown or near lockdown.”

Health vs prosperity

The government finds itself in the difficult position of trying to fight “two battles simultaneously: containing Covid and preventing the deterioration of the economy”, says Chen Long at Plenum, a Beijing-based consultancy. “Officials are told to win both,” he adds, “but the reality is they must prioritise one over the other. Zero-Covid still trumps the economy for now.”

This is true even while fears for the economy are being voiced by the premier Li Keqiang or by vice-premier Liu He, Xi’s most-trusted economic adviser who is particularly concerned about the lockdowns’ impact on the property and financial sectors.

Last weekend, Li warned that China’s “current employment trends are complex and grim” and called on “all localities” to prioritise protecting jobs to “ensure economic stability”. On Wednesday night, the State Council promised more relief measures for workers and employers, citing the pandemic’s “larger than expected impact” on the economy. But the localised approach to lockdowns makes it difficult for even municipal officials, let alone party leaders in Beijing, to assess their extent and economic impact.

One such official in the city of Nanjing, Jiangsu province, who asked not to be identified because he was not authorised to speak to foreign media, voiced his frustration: “The Politburo Standing Committee made it clear last week that fighting Covid was our top priority,” he says. “But we can’t ignore the economy, which is in freefall.”

His dilemma illustrates another difference between these local lockdowns and the national one two years ago. Because of the interconnected nature of China’s sprawling economy, companies in areas subject to moderate or even no controls can still be severely disrupted by the knock-on effects of those elsewhere.

The official says his “main job” has become lobbying his counterparts in Shanghai, 270km to the east, to authorise production at suppliers that Nanjing-based manufacturers rely on. “How can large firms operate normally when most of their suppliers are still under lockdown?” he says. “Stimulus won’t work if factories can’t return to normal.”

Foreign investors are also caught in the turmoil. Last week 60 per cent of more than 370 respondents to a survey by the EU Chamber of Commerce in China said they were lowering revenue forecasts for the year, while about one-quarter said they would move existing or planned investments out of China.

“If the current situation continues, [our members] will increasingly evaluate alternatives to China,” said Joerg Wuttke, the chamber’s president. “A predictable, functioning market is better than one that, despite having high growth potential, is volatile and suffers from supply-chain paralysis.”

The limits of stimulus

Wang’s difficulties in Henan are common across the cement industry. According to a nationwide survey by 100NJZ, a construction industry consultancy, shipments from 506 cement companies fell more than one-third in April.

An executive at state-owned Tangshan Jidong Cement Co, one of the largest in the industry, says new projects are not getting off the ground because of a lack of funding for local government financing vehicles, or LGFVs, which are crucial motors for the economy. “Stalled projects are everywhere,” he says.

Bond issuance by LGFVs was just Rmb758bn ($112bn) over the first four months of this year, down almost 25 per cent from the same period in 2021. Many Chinese banks now prefer to lend to infrastructure projects led by large state-owned enterprises rather than LGFVs, which they see as too risky.

They take a similar view of small and medium-sized enterprises in the private sector, which account for half of government tax revenues, 60 per cent of economic output and 80 per cent of employment. In March, researchers at Peking University surveyed more than 16,500 such businesses nationwide. First-quarter revenues were, on average, 73 per cent below the same period in 2019 — nine months before the pandemic hit. Average profit margins were 0.1 per cent, down from 1.8 per cent at the end of last year.

An executive at Bank of China’s branch in Zhengzhou, Henan province, who asked not to be named, explained the problem many lenders face. “The banking regulator asked us to beef up support for the economy by making more loans to LGFVs and SMEs,” he says. “But we will face heavy punishment in the event of defaults.”

Such reticence seems widespread. According to a nationwide survey of more than 100 loan officers by Shanghai-based Guosheng Securities, 44 per cent of respondents said their banks wanted to reduce exposure to LGFVs in coming months. About two-thirds said they expected loans for infrastructure and real estate development in the second quarter would either fall or, at best, match first-quarter issuance.

Attitudes such as these frustrate efforts by the State Council and People’s Bank of China to direct more credit to companies by cutting the level of reserves banks must maintain. Michael Pettis, a professor of finance at Peking University, says this kind of targeted easing “doesn’t solve the problem” in a lockdown-afflicted economy. “If you force banks to lend under [such] circumstances, the way they lend is not by satisfying unmet demand but by lowering their lending standards.”

Government officials and policy advisers say central bank officials want to boost growth by ensuring “appropriate financing demand” for LGFVs’ investments. But the securities regulator and planning ministry are more cautious. At the end of April the planning ministry issued new restrictions limiting LGFVs’ issuance of dollar-denominated bonds to 40 per cent of net assets.

“The authorities are trying to strike a difficult balance between supporting growth and keeping debt pressures from spiralling out of control,” says one Shanghai-based government policy adviser. They have good reason for concern. The total amount of outstanding interest-bearing debt issued by LGFVs is currently double that four years ago, standing at Rmb48tn.

Another hallmark of Beijing’s Covid stimulus policies, tax cuts, have offered little relief, according to many small business managers. In March, the State Tax Administration said SMEs would be exempt from paying value added tax until the end of the year. But, in practice, a business can only claim VAT relief on a transaction if the client waives its right to a VAT refund — something most are not willing to do.

Tax officials argue that the government cannot afford to give relief to both parties. “We can’t allow small firms and their clients to both enjoy tax breaks,” says an official at Beijing’s municipal tax bureau. “That would translate into a big drop in overall tax revenue just as local governments badly need money to fight the virus and finance infrastructure projects.”

Despite the intensifying economic pain, few expect Xi to relax his zero-Covid campaign before securing an unprecedented third term in power at a party congress later this year. The strategy “has become a political crusade — a political tool to test the loyalty of officials”, says Henry Gao, a China expert at Singapore Management University. “That’s far more important to Xi than a few more digits of GDP growth.”