Zero-Covid U-turn brightens China’s outlook

China-watchers have been caught off guard by the rapid shift away from zero-Covid policy in recent weeks, which has driven a strong rally in local markets.

A general consensus had formed that stringent measures to contain the spread of Covid-19 would remain in place at least until the spring. But the government has torn down many of the most restrictive requirements in the wake of October’s National Party Congress and some social unrest.

Removing restrictions implies that the number of Covid-19 infections in China will increase in the weeks ahead. After all, virtually every country that has transitioned away from some kind of restrictions has suffered an “exit wave” of rising infections.

There is a lot of uncertainty about how rising infections will affect China’s economy. The government has shifted the tone of its communications regarding the danger posed by the Omicron variant. However, relatively low vaccination rates among the elderly, along with general fear of infection, mean that there is a clearly a risk that a large exit wave could have a negative impact on activity. Indeed, a further decline in the various November purchasing managers’ indices (PMIs) coincided with a sharp rise in Covid infections that appears to have hit the services sector particularly hard. This may worsen in the near term.


In our recent forecast update we downgraded our expectations for Q4 growth for exactly these reasons, which reduced our full-year forecast for GDP growth in 2022 to just 3%.

However, at that time we remained relatively optimistic on the outlook since we continue to expect the economy to benefit from a cyclical recovery and expected GDP growth of 5% in 2023 and 4.2% in 2024.

The recent softening of Covid policy means that the risks to our forecast have now tilted to the upside, something that we started to track with our “China rapid re-opening” scenario.

There is a lot of uncertainty about how much disruption will be caused by the exit wave of infections. But ultimately, relaxing Covid restrictions will release the handbrake that has been holding back activity and allow for better transmission of existing policy support. Any further support for the housing market would clearly also be helpful.

As the grid below shows, the rapid reopening scenario is reflationary for the global economy. China’s large weight means that faster growth there would mechanistically lift world GDP growth. But the benefits are unlikely to be felt evenly. After all, the fact that China runs large external trade surpluses (exports more than it imports) means that it is not a major source of final demand and to the extent it does consume goods, this is concentrated largely in the commodities space.


This suggests that while commodity producers may feel some benefit from stronger activity in China, other economies may not. For example, the US runs a huge trade deficit with China and does not derive much growth from bilateral trade. And the fact that stronger demand in a reopening scenario is likely to be skewed towards services – something that has been evident around the world – suggests that growth in China will be less commodity-intensive than during past recoveries. Indeed, the eventual opening-up of China’s borders may mean that tourism destinations benefit as much as commodity producers.

The opinions contained herein are those of the author and do not necessarily represent the house view. This document is intended to be for information purposes only. The material is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The material is not intended to provide, and should not be relied on for, accounting, legal or tax advice, or investment recommendations. Information herein is believed to be reliable but Cazenove Capital does not warrant its completeness or accuracy. No responsibility can be accepted for errors of fact or opinion. This does not exclude or restrict any duty or liability that Cazenove Capital has to its customers under the Financial Services and Markets Act 2000 (as amended from time to time) or any other regulatory system. Cazenove Capital is part of the Schroder Group and a trading name of Schroder & Co. Registered Office at 1 London Wall Place, London EC2Y 5AU. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. For your security, communications may be taped and monitored. 

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