China Risks Going To Economic Hero To ‘Zero’ In 2022

Far from being a growth engine in 2022, China is setting itself up as the top risk to global economic stability.

Don’t take my word for it—take Ian Bremmer’s. Each year, Bremmer’s team at Eurasia Group puts out a top-risks list that’s a must read in market circles. And risks abound this year, from Russia to Iran to Turkey to climate to U.S. midterm elections.

Yet the biggest—China—might surprise many because it’s essentially the flip side of what saved world growth in 2021.

The reference here is to China’s success in generating 8.1% worth of gross domestic product in 2021 despite the pandemic. That included a 30.1% jump in imports, helping to share the benefits of China’s revival with demand starved Asian neighbors.

What worries Bremmer’s team at Eurasia, though, is President Xi Jinping’s stubborn attachment to the “zero Covid” scheme that worked so well in 2021. China, along with South Korea and Taiwan, proved that only by taming Covid-19 can economies get their grooves back.

Yet Omicron requires a very different response than the initial 2020 Covid strain or 2021’s Delta variant. Its transmissibility means Covid absolutism is futile. Omicron requires a more nimble and permissive containment strategy. In the Omicron era, vaccination rates are a better weapon than lockdowns.

Xi hasn’t gotten the memo. The massive lockdown in Xian, a Chinese city of 13 million people, suggests he has zero intention of recalibrating Beijing’s response. As harbingers of things to come, of China’s ability to keep growth above 5%, this one’s not promising.

As Bremmer sees it, “China is in the most difficult situation because of a zero-Covid policy that looked incredibly successful … but now has become a fight against a much more transmissible variant with broader lockdowns and vaccines with limited effectiveness.”

Not only might that lead to weaker mainland growth, but increased inflation. HSBC economist Frederic Neumann worries this Covid absolutism leads to the “mother of all supply chain stumbles.”

The concern, he says, is that “Asian production networks, hitherto impressively resilient, may be thrown into a funk as Omicron grips the region…and all at a time when, faintly, faintly, supply chain issues appear to be easing in the West. The risk, then, is that over the coming months we’ll experience” an “Omicron-driven stall” in Asia’s factories.

This domino effect worries the International Monetary Fund, too. On Friday, IMF Managing Director Kristalina Georgieva told CNBC that Beijing’s Covid imperative is increasingly looking like a “burden” to global GDP. “The zero-Covid policy, for quite some time, did contain infections in China,” Georgieva said. Now, she adds, “the restrictions that need to be imposed are more of a burden to the economy, putting more at risk not only [for] China but also China as a supply source for the rest of the world.”

These inflationary side effects are helping generate 7% consumer price increases in the U.S. Even deflation-plagued Tokyo is unnerved by the specter of importing too much inflation too fast.

Yet worries at Eurasia Group and the IMF about Xi’s zero-Covid obsession are only half the story. The other is Xi’s reluctance to recalibrate crackdowns on tech, property, education, entertainment and other sectors over which the Chinese state wants greater control.

In recent days, the People’s Bank of China has been cutting interest rates and upping liquidity to reduce default risks. Last year’s miss-payments fiasco involving developers like China Evergrande Group spooked markets. The defaults raised ill-timed questions about whether Xi’s crackdowns on leverage had gone too far. And hopes that Beijing regulators might throttle back in the interest of GDP rates.

Not so, Xi hinted last week. On Jan. 17, the same day China reported growth had cratered to 4% in the last three months of 2021, Xi told a World Economic Forum audience that anti-leverage policies remain the same.

“We will first make the pie bigger and then divide it properly through reasonable institutional arrangements,” Xi said. “As a rising tide lifts all boats, everyone will get a fair share from development, and development gains will benefit all our people in a more substantial and equitable way.”

While it’s hard to quibble with this aspiration, economists worry Xi is misreading Omicron. Xi is believed to be standing firm ahead of a Communist Party vote later this year, when he hopes to secure an unprecedented third term as Chinese leader. But political ambitions appear to be clouding his understanding of the shorter-term risks to Chinese living standards.

Such policy mismatches partly explain why the World Bank worries developing economies could be on track for a “hard landing,” says bank economist Ayhan Kose.

To be sure, China is very keen to tame Covid-19 and gain greater control over key industries. But the conditions facing Asia’s biggest economy are quite different from those it confronted in 2021.

Is China going from economic hero to zero in just one year really the legacy Xi wants? Until his inner circle gets the memo, and recalibrates accordingly, China’s policy mix is a clear and present danger to global growth.