The biggest wild card next year is the impact China will have on the global economy – and that hinges on whether it manages to successfully navigate a complicated exit from its Covid-Zero policy and reboot its economy at the same time.

Views are mixed, but one thing is certain, when it does make a comeback, it will change the lay of the land, broadening the economic dynamics that matter from the triad of high inflation, rising interest rates and a global economic slowdown that has dominated sentiment for the past year.

How China performs will have a considerable impact on the rest of the world, notwithstanding the shift in developed economies to increasingly look inwards for new sources of economic growth. 

China is the second largest economy, contributes a third to the global economic GDP, and, according to the Federal Reserve, in 2021 accounted for about 40% of global vehicle sales, 25% of global smartphone sales, 50% of global steel and coal demand and 14% of global oil demand. 

It is also the only major economy that is adding stimulus to the economy and not currently battling high inflation. 

The extent of the influence China has on the rest of the world becomes clearer in recent in-depth quantitative research done by the US Federal Reserve, which confirms that China is an important driver of the global financial cycle. 

That contrasts with the prevailing wisdom that China’s limited integration to the global financial system means that spillovers from China to global financial markets are small, it says.

In the Fed’s paper titled, What Happens in China Does Not Stay in China, the authors argue: “Despite China’s limited financial integration, spillovers from China reverberate through the global financial system through sentiment effects due to its importance as a driver of global business activity.”

Based on their research, they find fluctuations in Chinese demand affect global goods and commodity trade and conclude: “As such, higher economic growth in China raises global growth prospects, inducing a decline in aggregate risk aversion (with VIX the proxy for risk aversion) and an expansion in global asset prices and credit.”

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Their conclusions highlight what a difference it will make to the global economy and financial markets if China is, indeed, on the comeback trail. 

Events in early December have been encouraging, with the government’s emphasis shifting from stamping out Covid through its zero-Covid policies to focusing on growth. 

At the early-December Politburo meeting, according to IG Bank, most of the contents of the meeting notes focused on growth. Matters considered included advocating active fiscal stimulus and leveraging consumption and infrastructure to expand domestic demand. 

“It also mentioned policies for self-reliance technology.”

Critical to China’s 2023 economic prospects are that government moves slowly and carefully on rolling out its zero-Covid exit strategy and, in so doing, achieves a balance between this and putting in the requisite measures to get the economy going again. 

“Concerns regarding removing the Covid measures include the lack of ICU capacity in the event of an exit surge in cases, and the possibility that government may backtrack on its intention to remove zero-Covid policies and cause more uncertainty for investors after a highly unpredictable three years.”

FitchRatings Head of Greater China Sovereigns Andrew Fennell has not factored a fully fledged zero-Covid into his baseline view. He believes that several restrictions will remain in place and predicts that China’s export performance will be hampered by slower growth, and property developers’ operating environments will not significantly improve, notwithstanding the plethora of measures the government has instituted to do just that.

The bottom line for him: “These combined factors will weigh on consumption, business confidence, and constrain the trajectory of mainland China’s economic recovery.”

Oxford Economics has spelt out three possible zero-Covid exit scenarios and what these mean for the world and China. 

The first scenario is an early reopening in the first half of 2023, which it views as still a low-probability scenario that it puts at 10%. The second scenario also has a low likelihood (10%) of occurring and is a delayed reopening in 2024 or even later.

Finally, the scenario it views as most likely is a reopening in the second of 2023 and attaches a 60% probability to this outcome for China.

In answering the question – will China’s economy recover in 2023? – IG Bank believes that if the Chinese government reopens into the New Year, it will have great potential to make a strong rebound next year.

A recovery in the property market, which contributed one-third to China’s GDP when it was in good shape, will add to the economic momentum based on the Chinese authorities’ 16-point plan for the sector, which included extended developer borrowings and mortgage repayments.

However, it stresses: “The journey ahead won’t be an easy one. On one hand, rising infections in a country with 1.4 billion people that have barely been exposed to the virus suggests an ‘exit wave’ is unavoidable.”  On the other hand, it says, the demand for housing is likely to take longer to recover.

“Last but not least,” it says, “is the unpleasant fact that the past three years of harsh lockdowns have forced many world-class companies to exit or reduce their reliance on the Chinese market, including Apple, Amazon and Samsung. 

“The severe damage that has been done to China’s labour market, manufacturing value chain, and export demand is unlikely to be reversible.”

It may be premature to get excited about the prospect of China being on the comeback trail, but there’s no doubt that, with the government’s focus swinging to the economy, China is coming back in the next few years – and once it does, the world economy will face the prospect of the much-anticipated new global order emerging. BM/DM