China’s ‘Zero Covid’ Mess Is Infecting Asia’s Economies

Ten years of President Xi Jinping trying to increase Chinese soft power in Asia risks becoming a big zero.

For that, Xi has his stubborn embrace of a “zero Covid” strategy rapidly backfiring on the second-biggest economy to blame. The anemic 0.4% growth China produced in the April-to-June period year-on-year is a galaxy away from the 5.5% output Xi earmarked for 2022.

And judging by the Asian Development Bank’s latest numbers, it’s winning Xi few friends in the region. China’s gross domestic product miss is dragging neighbors down, too. ADB just lowered its growth forecast for developing Asia to 4.6% from 5.2% this year largely thanks to slowing Chinese growth.

Yet, as private-sector economists agree, this is likely to prove overly optimistic. The Federal Reserve’s tightening cycle, for example, is still in the early stages. Global inflation continues to slam corporate and household confidence.

Fallout from Russia’s Ukraine invasion on global food and energy costs and supply chains could still get a lot worse. The U.S. dollar’s powerful rally is luring tidal waves of capital away from Asian markets, leaving economies starved for liquidity.

This dynamic has the potential to increase Chinese default risks, another threat to Asia. Over the last year, highly indebted property developers have had trouble making payments on overseas loans. The yuan’s 6%-plus drop this year makes those liabilities even harder to service.

Debt reckoning or not, China’s year is rapidly getting away from Xi—and Asian neighbors who planned to ride its coattails. Xi’s zero Covid obsession—and massive lockdowns of entire metropolises—is out of step with today’s far more transmissible variants.

The answer is better vaccines, smarter contact tracing, testing and savvier mitigation strategies, not forcing tens of millions to shelter in place in this city or that one. Sadly, Xi ensnared China in the very trap geopolitics wonks including Ian Bremmer feared.

In January, Bremmer, CEO at Eurasia Group, warned that “China’s zero Covid policy, which looked incredibly successful in 2020, is now fighting against a much more transmissible variant with vaccines that are only marginally effective.”

Xi’s intransigence is complicating his longtime plan later this year to secure a norm-breaking third term as Chinese leader. Odds are very high that Xi will get his way, but the coronation might now be less enthusiastic as growth flatlines.

The same goes for average consumers boycotting mortgage payments amid widespread delays in completing giant development projects. The standoff is a tantalizing microcosm of China’s bubble troubles.

Qi Wang, CEO of MegaTrust Investment, finds great significance in reports that Xi’s government is devising a property stabilization fund. “The real estate problems are worsening by the day, and China needs to act fast to stop the problems from spreading,” he says.

Here, think fallout from Japan’s glacial response to the implosion of the 1980s “bubble economy.” Thirty years on, that era of complacency continues to limit growth and risk-taking on the part of Japan Inc. and young entrepreneurs who might otherwise create new generations of tech “unicorns.”

This “balance sheet recession,” as Nomura Research Institute economist Richard Koo dubbed it, occurs when assets plunge in value steadily and relentlessly over a number of years. Last month, Beijing think tank China Finance 40 Forum warned that “many developers are facing serious balance sheet problems” thanks to overexpansion colliding with Covid growth shocks and Xi’s regulatory efforts to curb leverage.

Bottom line, the forum argues, “China’s macro economy is likely to experience a weak expansion in the face of balance sheet damage.”

Economist Craig Botham, an economist at Pantheon Economics, agrees. “We think China entered a balance sheet recession in Q2, and policy needs recalibrating to fix. The combination of the property downturn, tech crackdown, and zero Covid have hit asset values.”

The Chinese bailout fund, Wang notes, “could be targeted at resolving the recent mortgage boycotts, or providing direct financial support to the real estate developers, among others. Regardless, this should prevent a wider financial crisis, and more importantly, the related social unrest.”

There’s always hope that Beijing might realize the error of its ways. Economist Carlos Casanova at Union Bancaire Privée points out that Chinese Premier Li Keqiang is talking about refining Covid policies to minimize the economic costs.

Trouble is, China has been hinting at a “dynamic zero Covid” approach since at least January. And any pivot might come gradually. “This is exactly in line with our below-consensus GDP growth forecast of 3.7% for 2023,” Casanova says.

Analyst Zerlina Zeng at advisory CreditSights points out that China is also dusting off its old playbook of infrastructure stimulus to counter the negative impact of the zero Covid policy and a property downturn.

Based on Beijing’s budget statement in the first half of the year, Zeng expects ramped-up capital expenditures by the central and local governments. This would include massive spending on urban/rural infrastructure, land development, agriculture, water treatment, utilities and transportation.

Regardless of how China does it, it must find a way to move its economy from zero back to hero in the eyes of Asian leaders. Embracing a less draconian Covid policy is as good a place to start as any.