The China problem

19th May, 2022

Amid all the turmoil in Western markets, the resurgence of Covid in China hasn’t created much of a splash. However, its dire impact on the Chinese economy was laid bare this week, with reports that retail sales had dropped over 11% year on year and industrial production had fallen almost 3%. Both statistics startled economists, who had expected weakness, but not on this scale.

There are plenty of reasons why this weakness may be temporary. The Chinese government recognises the cost of its zero Covid policy and the need for vaccines and anti-virals to prevent future lockdowns. It has approved Pfizer’s anti-viral drug, the first approval China has given to a drug or vaccine developed by a foreign country for Covid-19, and has made progress on its own MRNA technology vaccine. 
China has already reversed monetary policy, which should put more liquidity in the economy. The government is likely to be wary of repeating the mistake of the global financial crisis, when China unleashed a fiscal package of 4 trillion yuan ($586 billion), leaving it with an uncomfortable debt legacy. However, it has shown a willingness to support the economy in the face of its current weakness. Fewer inflationary pressures give the Chinese central bank the flexibility to do this. 
Equally, the regulatory threat may not be as bad as expected. While the government is looking to address the ‘disorderly expansion of capital’, it appears to recognise the importance of the private sector and innovation. The measures it has taken are not dissimilar to those that many Western powers want to take to curb the influence of the technology sector. While it has alerted investors to the willingness of the Chinese government to clamp down on the private sector, it does not look extreme. 
Perhaps the most worrying element for China is technology decoupling and how it hits Chinese innovation. Tensions between the US and China have been rising, particularly in the wake of the Ukraine crisis. It seems vanishingly unlikely that China will be allowed the flexible access to US technological intellectual property that it has enjoyed to date. Oxford Economics says this technology decoupling could have a significant, long-term impact on economic growth. 
Chinese markets look cheaper than they have done for some time, with the MSCI China index trading at 10.5x forward earnings, compared to 16.2x for the MSCI World index. There may be more pain to come in Chinese markets as growth slows, but value has started to emerge and the outlook may not be as gloomy as is currently expected.

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