After such a strong recovery from Covid-19 last year, 2021 was always going to be a different story for China. After all, China led the macroeconomic recovery from the initial outbreak of the pandemic; the so-called “first-in-first-out” effect.

However, regulatory reforms, the energy crisis and real estate volatility as a result of regulatory actions and concerns over Evergrande, have proven additional issues for markets to negotiate. And this led to some contrasting performance between bond and equity markets in 2021.  

From a Covid perspective, China has now double vaccinated over 75% of its population. At the same time, it has maintained a strict border control, with quarantine requirements still in place. With uncertainty created by the Omicron variant, these look set to remain in place into next year.

There are multiple considerations to weigh up for 2022. Will the zero-tolerance Covid approach be lifted; can slowing economic growth begin to ease; and are regulatory pressures set to lessen?

China’s economy

David Rees, Senior EM Economist

The sharp slowdown in China’s economy that began in the second half of 2021 will spill over into 2022, ensuring that GDP growth will remain slow. We have pencilled in GDP growth of 4.7%, down from a projected 7.7% in 2021.

While the government’s zero-tolerance Covid-19 policy remains in place, restrictions to contain outbreaks of the virus will continue to periodically hit activity, particularly in the services sector. The arrival of the Omicron variant is a concern in this regard. Government intervention has greased the wheels of the energy sector after blackouts hit activity. Even so, coal reserves are likely to remain stretched through winter at the very least. As a result, manufacturers face higher energy costs at a time when demand for exports looks set to soften.

However, it is the real estate sector that is of most concern. A crisis of confidence regarding the health of highly indebted developers has caused sales of new property to dry up, taking away a key source of financing and leading to a downward spiral of weaker construction activity, more debt restructurings and weaker sales. Policymakers have shown a greater pain threshold for problems in the real estate sector, consistent with the government’s broader regulatory reforms aimed at achieving “common prosperity”. But the authorities are likely to step in at some point to steady the ship, given the potential negative consequences for the financial system and economy at large from a complete meltdown in the housing market. Even so, the lags between weak sales of land and new properties and activity mean that construction will be weak in 2022 and this sector has historically been equivalent to about one fifth of GDP.

The good news is that none of this will be complete surprise to markets. Incoming data may still surprise on the downside in the near term, but our long held concerns about a slowdown in China have now become the consensus view and markets will be focusing on any signs of improvement. An announcement of fiscal stimulus, perhaps geared towards investment in the energy transition, could give a shot in the arm to confidence.

We will also be looking for an upturn in leading economic indicators for signs of future improvement. For example, while the credit impulse - the 12 month change in new lending as a share of GDP - continued to decline in October 2021, signalling soft economic conditions into the summer of 2022, it did so at a slower pace. The impulse may trough and pickup around the turn of the year implying an improvement in activity in the second half of 2022.