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February 3, 2023
How Will China’s Reopening Play Out?
The transitional pain is much shorter than previously expected … The economic recovery will start in the current quarter with 7% quarter-over-quarter growth (seasonally adjusted annual rate, or SAAR), followed by 7.4% in the second quarter, 5.5% in the third quarter and 6.1% in the fourth quarter.
Haibin Zhu, Chief China Economist and Head of Greater China Economic Research, J.P. Morgan
Reopening will be the biggest catalyst for China’s economic recovery in 2023. However, the earlier and faster-than-expected reopening led to a spike in COVID-19 infections which caused major disruption in December. While the government has stopped publishing daily infection cases, J.P. Morgan estimates the infection ratio had risen to about 40% of the total population by the end of 2022, with herd immunity reached in January, up from less than 1% in November 2022.
High-frequency activity during the Lunar New Year holiday points to a recovery in domestic consumption, especially in sectors that are sensitive to COVID-19:
- Passenger traffic rose 76% compared to 2022 but was still 47% lower than 2019 levels. Meanwhile, the Baidu mobility index was 41% higher than 2022 and 26% higher than 2019.
- Lunar New Year consumption was 6.8% higher than it was in 2022. Sales of food, clothing, jewelry and autos rose 9%, 6%, 4.4% and 3.6% respectively.
- Tourist numbers were 23% higher than in 2022, reaching 89% of 2019 levels. Tourist revenue was 30% higher than in 2022 — 73% of 2019 levels.
- Movie box-office revenue was 11.9% higher than it was in 2022 and 14.6% higher than in 2019.
In addition, there was no new infection wave during the Lunar New Year break, which paves the way for domestic production and consumption normalization in the coming months. “Putting everything together, it appears that China’s economic recovery is more front-loaded compared to our baseline forecast,” said Haibin Zhu, J.P. Morgan’s Chief China Economist and Head of Greater China Economic Research. “The economic recovery will start in the current quarter with 7% quarter-over-quarter SAAR growth, followed by 7.4% in the second quarter, 5.5% in the third quarter and 6.1% in the fourth quarter.” Full-year GDP growth forecast stands at 5.6%.”
Will Inflation Spike in China After Reopening?
We look for headline CPI inflation to average 2% year-over-year in 2023.
Haibin Zhu, Chief China Economist and Head of Greater China Economic Research
Across the rest of the world, slowdowns in growth can mainly be attributed to high inflation. In China, they are mainly due to the Omicron drag. China has been an outlier compared to the rest of the global economy, facing broad-based disinflation with lagging demand recovery despite steady production recovery. The consumer price index (CPI) averaged 2% growth in 2022 — which is below the 3% target — and the producer price index inflation was negative throughout the fourth quarter of 2022.
The major factor that will affect inflation this year is the rapid reopening of the economy, with consumer prices expected to recover from the second quarter of 2023. While there are risk factors, J.P. Morgan Research predicts that inflation will stay in check. “We expect CPI inflation to stay below 2% for most of this year, before turning up and approaching 3% toward the end of the year and into 2024,” said Zhu. “Overall, we look for headline CPI inflation to average 2% year-over-year in 2023.”
CPI, core CPI and PPI inflation in China
CPI, core CPI and PPI inflation are all forecast to rise in 2023 after an initial dip, following the reopening of the economy.
However, there are concerns that pricing pressure may spiral out of control and accelerate significantly during reopening, adding stress to global inflation throughout 2023. There are two main risk factors:
Following the rapid removal of COVID-19 restrictions, there have been notable supply chain issues stemming from labor shortages and transportation delays, lengthening delivery times. These are likely to be temporary though, as production activity should normalize into March.
The post-reopening rebound will drive up private consumption and spending on services as pent-up consumer demand is realized. This will have a major impact on inflation, with core CPI ticking up toward 3% by the end of 2023. Core CPI inflation should average 1.3% year-over-year in the first half of 2023, rising to 2.9% in the fourth quarter.
“Tourism and entertainment prices will likely face upside pressure, while housing and rental pressure should remain modest amid a sluggish property market,” said Zhu. “All in all, we look for a gradual recovery.”
China’s Housing Market: Will the Policy Pivot Work?
A strong housing market rebound looks unlikely … housing policy relaxation is weaker than it was during the 2015-16 rebound and there is no large-scale stimulus package.
Haibin Zhu, Chief China Economist and Head of Greater China Economic Research
Across sectors, housing was the largest drag on China’s economic growth in 2022 and the market registered record-low activity, despite policy adjustments introduced from late 2021. In 2022, new home sales (in floor space) fell 26.8%, new home starts fell 39.8% and real estate investment fell 10%.
The declining real estate market
Floor space started, floor space sold and real estate investment are expected to continue falling after spiking in 2021 then declining in 2022.
In November last year, the People’s Bank of China (PBOC) and China Banking and Insurance Regulatory Commission (CBIRC) announced a 16-point rescue plan for the housing market, marking the most significant shift in housing policy since 2016. “On the investment side, this is a game changer for prudent private developers,” said Zhu. “The November measures explicitly address developers’ funding problems.”
In an attempt to boost demand, further measures have followed, which focus on lowering down payments and relaxing restrictions around purchasing a home. This indicates that housing has become a policy priority and highlights the importance of achieving stability in the market.
Why Is China Focusing on the Housing Market?
The dramatic changes to housing policy come after concern over risks to financial stability as well as a desire to achieve growth stabilization. The major housing market correction which has been under way since the second half of 2021 has led to rising developer defaults, increasing pressure on local governments and a collapse in land sales. Further correction runs the risk of accelerating house price declines, which have so far only been minor. Other negative outcomes include increasing financial risk for households as well as the potential for a balance sheet recession.
Will China’s New Housing Policies Be Effective?
- Short-term housing activity has remained subdued due to COVID-19 constraints, low income expectations, concerns about home delivery and weak house price expectations.
- The housing market will likely reach its lowest point in the second quarter of 2023 and some of the current obstacles will begin to fade.
- Longer term, a strong rebound in housing activity looks unlikely and demand is a major constraint.
House prices have mainly held steady in China
While floor space sold and floor space started have mainly followed a downward trend since December 2020, the 70-city home price remained largely unaltered through to September 2022.
One of the main drawbacks is the geographical limitation of measures designed to boost housing demand. One such measure is a dynamic adjustment mechanism on mortgage rates for first-time homebuyers, but cities can only implement this if they have seen home prices declining over three consecutive months.
“Even with the changes that have been made, housing policy relaxation is still weaker than it was during the 2015-16 rebound,” added Zhu. “There is no nationwide reduction of down payments or housing transaction costs. Some home purchasing restrictions have been removed but only in a few cities and most importantly, there is no large-scale stimulus package such as the monetary subsidy for shanty town renovation in the 2015 episode.”
How Much Debt Does China Have and Will It Continue to Rise?
After debt reached a historical high in the last year, we expect that total debt to GDP will rise another 10 percentage points in 2023.
Haibin Zhu, Chief China Economist and Head of Greater China Economic Research
J.P. Morgan estimates that China’s total debt to GDP ratio increased by 11 percentage points to a historical high of 285% in 2022. It is expected that total debt to GDP will rise another 10 percentage points in 2023.
China’s total non-financial debt
China’s total debt to GDP ratio hit a historical high of 285% in 2022 and is anticipated to rise further in 2023. Total debt outstanding has steadily risen from 2007 to 2023.
- Government debt will increase by 3.9 percentage points. This has been the front-runner in total debt cumulation, in particular due to local government activity.
- Corporations will add 3.7 percentage points. Despite this relatively large contribution, corporate debt shrunk from 64% in 2019 to an average of 60% during the first three quarters of 2022.
- Households will add 2.2 percentage points. The growth rate of household debt has been higher than that of corporate debt since 2015, aside from a reversal in the third quarter of 2022 during a housing downturn.
Drivers of debt in China
Corporate debt, government debt and household debt are the main drivers of debt in China. The growth rate of corporate debt has been lower than that of government and household debt since 2015, other than the marginal reversal with household debt in the third quarter of 2022.
While corporate debt has grown more slowly in recent years, this does not necessarily imply less vulnerability — perhaps the opposite, as corporate balance sheets have been deteriorating since the outbreak of the COVID-19 pandemic. In fact, small and medium-size enterprise (SME) loans have grown faster than other corporate loans and could be a possible vulnerability in 2023, with the potential for defaults to rise rapidly once COVID-19 rescue measures expire.
The other major risk factor is debt from local government financing vehicles (LGFV), which are set up to fund public projects. As they are similar to state-owned enterprises, their debt is classified as corporate debt and at 44% of GDP, it represents a significant amount. LGFV projects often have low profitability so their debt repayment capacity is weaker, especially during an economic downturn. What’s more, LGFVs are directly involved in the property market — they bid for land and may play an essential role in the provision of affordable rental housing. This could make them susceptible to housing market corrections and increase debt further, though the government is taking action to protect pricing and retreats have been modest so far.
Will China’s Monetary Policy Ease?
We believe that monetary policy will ease slightly in 2023 … The probability of a rate hike by the PBOC in 2023 is very low.
Haibin Zhu, Chief China Economist and Head of Greater China Economic Research
- J.P. Morgan forecasts another rate cut of 10 basis points in the first quarter of 2023. However, this will mark the end of the rate cut cycle. It will be justified by slow growth year-over-year and low inflation in the near term, but as the economy starts to recover strongly in the second quarter of 2023, the PBOC will keep rates unchanged. “The probability of a rate hike by the PBOC in 2023 is very low, in our view, due to the absence of overheating economic activity or inflation,” said Zhu.
- Credit policy will remain relatively stable. Credit impulse — the flow of new credit issued — was neutral throughout 2022 and the forecast for total social financing (TSF) growth is 9.5% in 2023. This is 3-5 percentage points higher than nominal GDP growth, similar to credit policy at the end of 2022.
- Structural monetary policy will continue to support targeted sectors in coordination with fiscal policy. The link between the two is an interesting new development and the format could be expanded into other areas in the future.
Another key question is whether China will adopt its own method of quantitative easing — a form of monetary policy where a central bank purchases government bonds or other financial instruments to increase money supply and lower long-term interest rates. The answer is not completely clear yet. PBOC Governor Yi has rejected the proposal, however the debate is unlikely to go away and will be one to watch in relation to China’s future monetary policy.
Adapted from J.P. Morgan’s economic research report “Ten questions about China in 2023”, January 10, 2023, by Haibin Zhu, Grace Ng, Tingting Ge and Ji Yan.
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