Will China galvanise or destabilise the global economy?

In a league table of economic growth, the UK would be languishing somewhere near the bottom this year: according to the International Monetary Fund (IMF), we will be the only advanced economy to face a contraction in 2023. But China would be back near the top of the table – the IMF expects Chinese gross domestic product (GDP) to grow by 5.2 per cent (see chart). 

As China relaxes its strict pandemic curbs, three years’ worth of pent-up demand will be released. The impact on the Chinese economy will be considerable: economists at UBS expect China’s GDP to expand by almost 5 per cent in 2023, up from 2.7 per cent last year. Between them, China and India are expected to drive half of global growth this year – versus a tenth for the US and euro area combined.

The Chinese economy accounts for between 15 and 20 per cent of world GDP. If its growth rate does double this year, the impact on global economic growth could be huge. Goldman Sachs economists Joseph Briggs and Devesh Kodnani  estimate that every 1 percentage point increase in China’s GDP increases broader global growth by 0.2 percentage points. As a result, a full recovery in Chinese domestic demand could raise global GDP by 1 percentage this year.

The impact of reopening will filter through to national economies, too – although some more than others. Luxury exporters are hopeful that Chinese ‘revenge spending’ will see demand surge, while a resurgent tourism industry could also deliver an economic boost. There is also the possibility that reopening will increase energy demand, benefiting oil exporters – but weighing on real incomes and growth elsewhere. 

Revenge spending 

Chinese reopening is still in its early stages, but figures from the lunar new year period suggest that consumers are keen to make up for lost time. Figures from TS Lombard show that revenues from tourism and hospitality jumped by 130 per cent year on year over the holiday period, achieving 80 per cent of pre-pandemic lunar new year levels.

A return to normal spending patterns will be good news for Chinese companies: Gabriela Santos, global market strategist at JPMorgan Asset Management, thinks that Chinese ecommerce and consumer discretionary companies will benefit from increased demand (once infections reach their peak, at least). 

This desire for revenge spending may well extend to luxury goods. Santos notes that two-thirds of the world’s top luxury goods companies are listed in Europe, and expects European equity markets to benefit as a result. Analysts at Bank of America estimate that Prosus (NL:PRX) has 80 per cent sales exposure to China, while luxury carmaker BMW (DE:BMW) has 43.2 per cent. Chris Iggo, Chair of the Axa IM Investment Institute, notes that increased export demand from China is “already a theme behind the outperformance of European equities in recent weeks”.

But are markets getting ahead of themselves? Bank of America analysts are sceptical that China’s reopening will have much impact on European economies. They think that China’s rebound will be skewed towards demand for services, rather than goods, meaning less support for the euro area economy via export demand. Goldman Sachs’ Briggs and Kodnani expect the impact on goods exports to deliver only a modest growth boost outside of Asia-Pacific economies. 

Could a tourism boom have spillover effects further afield? Briggs and Kodnani expect international travel to drive a recovery in demand for foreign services, providing a modest boost to global growth. Since 2019, travel expenditure has plummeted, as the second chart shows. Yet before the pandemic, Chinese tourists spent $254.6bn on outbound travel – more than twice as much as their US counterparts. 

But the UK may not benefit from a tourist-led boom – before the pandemic hit, China was below Hungary, Portugal and the UAE as a source market for UK tourism inflows. Thailand, the most popular pre-pandemic destination for Chinese tourists, could stand to benefit significantly. JP Morgan’s Santos expects overseas spending to support broader Asian equity markets, such as Japan, Singapore and Thailand, where China represents the largest source of tourist revenue. 

Inflationary impacts

There are (well-founded) fears that releasing the pent-up demand of 1.4bn people will fuel global inflation. But supply-side improvements from China’s reopening mean that the overall impact could prove more nuanced. 

On the plus side, improved manufacturing activity will ease supply chains, helping global inflation to maintain a downward trend. Goldman Sachs analysis suggests that these supply chain improvements could lower US core inflation by around 0.1 percentage points. This would be music to the Fed’s ears, and, in theory, the impact of China’s reopening could mean a swifter end to rate hikes in advanced economies this year. 

In reality, however, the disinflationary impact of supply chain improvements will probably be offset by commodity price pressures. Santos thinks that normalising travel patterns will increase China’s demand for diesel and jet fuel, which will keep oil prices supported even as the rest of the world sees demand decelerate. Goldman Sachs commodity strategists estimate that the overall impact of China’s reopening could increase US inflation by half a percentage point, and “moderately boost headline inflation in most other economies”, too. 

Although higher oil prices will benefit oil exporters, they will curb real incomes and growth prospects elsewhere. Analysts at Oxford Economics said that a sudden and significant increase in oil prices would weigh heavily on low-income US households, who have largely used up excess savings accumulated over the course of the pandemic. As a result, they take the view that China’s reopening will prove a ‘net neutral’, rather than a boost, for the US economy. 

Risks to a rebound 

There is also a risk that reopening will not proceed smoothly. IMF chief economist Pierre-Olivier Gourinchas warns that China’s recovery could still stall amid disruptions from waves of Covid infections. The Bank of England’s latest monetary policy report noted that rising cases were weighing on activity in China as the population turned to voluntary social distancing. Bank staff expect high case levels to reduce consumption and output in the near term, leading to a contraction in the first quarter of this year. 

Analysts at Oxford Economics also warn that “while reopening has been swift, domestic demand conditions are starting from a much weaker point”, and add that “confidence and incomes are too frail for a quick recovery”. What’s more, they believe that reopening could exacerbate the strain on households, labour markets and government finances, which are already scarred after three years of episodic lockdowns. Oxford Economics analysts expect near-term growth to suffer as a result. 

Rory Green, chief China economist at TS Lombard, is more optimistic about Chinese consumption, and thinks that it could rebound initially (albeit from a low base). But he argues that China’s recovery could soon stall if the property market slump proves hard to move on from. Research from TS Lombard suggests that sales across the top 100 Chinese property developers fell by 45 per cent year on year last month, as concerns about price drops weighed on the market. Green thinks that “property-related scarring will keep a large chunk of China’s Covid-era savings in the bank”, meaning that consumption will slow after an initial reopening surge. 

Beyond reopening excitement 

There are also profound issues to contend with once this reopening surge recedes. Axa IMs Iggo highlights long-term concerns about demographics and the risk of China’s technological development being restricted by US sanctions over their approach to Taiwan. But for now, he notes that “these are unlikely to stop strong near-term gains in the Chinese equity markets”. 

Economists at Goldman Sachs Asset Management (GSAM) are among those who warn that reopening the world’s second-largest economy will not be straightforward. They recommend that investors keep a close eye on developments in the goods trade, international travel and commodity channels over the coming months. As my colleague Julian Hofmann notes in ‘Return of the Dragon’, investors can look for value by stockpicking, or by following an index such as MSCI China to see if they can benefit from the profits that a return to growth should bring. 

But despite the challenges, interest in China is unlikely to wane. GSAM economists believe that the housing market downturn, geopolitical tensions and technology restrictions will keep China in focus long after the “reopening excitement” subsides.