China in Transition

China's Economy to Slow Down in 2022
—The Prospects of the Housing Market and COVID Control in the Spotlight

Chi Hung KWAN
Consulting Fellow, RIETI

Ⅰ. Introduction

The Chinese economy, which showed a V-shaped recovery from the recession prompted by the initial COVID crisis in the first quarter of 2020, has started to slow down after its GDP growth peaked in the first quarter of 2021. The economic growth rate reached 8.1% for 2021 as a whole, significantly higher than the 2.2% recorded in 2020. However, on a quarterly basis, the pattern of "starting low and ending high" seen in 2020 was reversed in 2021, with the GDP growth rate falling to 4.0% in the fourth quarter. The Chinese economy is expected to remain sluggish in 2022 in the face of adjustments in the housing market and uncertainty surrounding the COVID situation.

Ⅱ. China's Economy Has Been Slowing Down since the Second Half of 2021

The spread of COVID-19, which began in China in early 2020, eventually developed into a global pandemic that has yet to be contained. China took strict measures in infected areas from an early stage, such as large-scale testing and population movement restrictions, including lockdowns, and the spread of the disease was brought under control around March 2020 (Figure 1). Since then, small-scale localized outbreaks of COVID-19 have occurred, but large-scale widespread reemergence has been avoided, and the number of infected people and deaths has been kept at a very low level compared to other countries. By the end of January 2022, the total number of people infected with COVID-19 worldwide was over 370 million, and the number of deaths exceeded 5.6 million, while in China, which accounts for almost 20% of the world's population, the numbers were less than 120,000 and 5,000, respectively (Note 1).

Figure 1. Number of Newly Confirmed Cases of COVID-19 Infection in Mainland China
Figure 1. Number of Newly Confirmed Cases of COVID-19 Infection in Mainland China
Source: Compiled by the author based on data from the National Health Commission of the People's Republic of China.

In line with these developments, the Chinese economy showed a V-shaped recovery, after shrinking 6.9% (year-on-year) in the first quarter of 2020. China's economic growth rate reached a high of 18.3% in the first quarter of 2021, partly due to a rebound from the significant decline in the previous year, significantly widening the gap with Europe and the United States. However, the pace of recovery has since slowed, and the GDP growth rate in the fourth quarter of 2021 fell to 4.0%, below the levels of the US (5.5%) and the EU (4.6%) (Figure 2).

Figure 2. GDP Growth Rates of China, the U.S., and the EU during the Recovery from the COVID Crisis
Figure 2. GDP Growth Rates of China, the U.S., and the EU during the Recovery from the COVID Crisis
Source: Compiled by the author based on data from the National Bureau of Statistics of China for China, the U.S. Bureau of Economic Analysis for the U.S., and Eurostat for the EU.

The contribution of net exports to China's GDP growth rate (year-on-year) was consistently positive during the recovery process from the COVID crisis, compensating for the shortfall in domestic demand resulting from weakening consumption and investment (Figure 3). This phenomenon can be seen as reflecting the asymmetry of the supply-demand gap between China and other countries. In China, production is recovering one step ahead of demand, and supply is exceeding demand, while in other countries, due to the governments' large-scale economic stimulus measures, the recovery in demand is ahead of production, and demand is exceeding supply. The increase in net exports in China is offsetting these two gaps.

Figure 3. Changes in the Contributions of Demand Components to China's GDP Growth Rate
Figure 3. Changes in the Contributions of Demand Components to China's GDP Growth Rate
Source: Compiled by the author based on data from the CEIC database (original data from the National Bureau of Statistics of China).

Despite the economic slowdown, the Producer Price Index (PPI) in China rose by double digits to 10.3% year-on-year in December 2021. In contrast, the Consumer Price Index (CPI) rose only 1.5% in December 2021, with the wide gap between the two highlighting the weakness in final demand (Chart 4). While this has helped improve the performance of companies upstream in the supply chain (mainly state-owned enterprises), it has worsened the performance of companies downstream (mainly non-state-owned enterprises) that have not been able to pass higher input prices through to output prices.

Figure 4. Trends in PPI and CPI in China
Figure 4. Trends in PPI and CPI in China
Source: Compiled by the author based on data from the National Bureau of Statistics of China.

Given that the PPI is a leading indicator of the CPI, the current rise in the PPI is likely to raise the CPI to some extent in the future. With GDP growth expected to remain low, if the inflation rate rises, the Chinese economy will enter a phase of stagflation. The government has been implementing monetary easing measures, such as lowering interest rates and the reserve requirement ratio for banks in an attempt to halt the decline in GDP growth, but the scope for doing so is limited by growing concerns about inflation.

The low growth since the second half of 2021 reflects the spread of COVID-19 in some areas and the government's tightening of restrictions on economic activities to contain it. Among the affected regions, Xi'an, with a population of 13 million, was under a month-long lockdown from December 23, and major cities such as Tianjin, Ningbo, and Shenzhen also saw a series of closures of some factories and port facilities.

In addition to the spread of COVID-19, the severe power shortage in the summer of 2021 also added to the economic downturn. One of the reasons behind the power shortage is that China had been closing down coal mines and coal-fired power plants with high CO2 emissions in order to meet its international pledge to see its CO2 emissions peak by 2030 and achieve carbon neutrality by 2060. On top of that, with the price of coal skyrocketing while the end price of electricity is controlled by the government, power companies were unable to pass on the higher costs of coal to consumers and decided to limit the supply of electricity in order to halt the deterioration of their profits. In response, the government eased restrictions on coal production and also allowed companies to raise electricity prices, largely eliminating the power shortage since the fourth quarter.

Meanwhile, the housing market has entered an adjustment phase, triggered by the debt crisis facing China Evergrande Group and other Chinese real estate companies that came to light in September 2021 (Figure 5). The growth rates (year-on-year) of home sales area and housing investment have already fallen into negative territory, and the growth rate (year-on-year) of the new commodity home sales price index (the average of the 70 largest and medium-sized cities) has also slowed (the month-on-month growth rate has been negative since September 2021).

Figure 5. Changes in Key Indicators of the Housing Market in China
Figure 5. Changes in Key Indicators of the Housing Market in China
Note: The "housing prices" series is the simple average of the change in the individual indices in 70 large and medium-sized cities. As data for "floor space of residential housing sold" and "housing investment" are published in aggregate for January and February, the chart shows the same figure for both months.
Source: Compiled by the author based on data from the National Bureau of Statistics of China.

Ⅲ. Concerning Impacts of Housing Market Adjustments

As of 2020, the ratio of home sales prices to household disposable income in China's major cities, including Shenzhen (39.8 times), Shanghai (26.2 times), and Beijing (23.8 times), has already surpassed that of Tokyo (less than 20 times) during the bubble period in the late 1980s (Figure 6). Housing prices can fall a significant amount before they return to reasonable levels. Real estate is a key industry for China, and the decline in housing prices is expected to have a significant impact not only on the real side of the Chinese economy, but also on its financial and fiscal sides (Figure 7).

Figure 6. Ratio of House Prices to Average Household Disposable Income in Major Chinese Cities (2020)
Figure 6. Ratio of House Prices to Average Household Disposable Income in Major Chinese Cities (2020)
Source: Compiled by the author based on data from "Report on the Ratio of Income to Housing Price in 50 National Cities," Shanghai Institute of Housing and Real Estate Research, March 29, 2021.
Figure 7. Size of the Real Estate Industry in China (2020)
Figure 7. Size of the Real Estate Industry in China (2020)
Source: Compiled by the author based on data from the National Bureau of Statistics of China, the Ministry of Finance, and the People's Bank of China.

First, in real economic terms, housing investment in 2020 amounted to 10.4 trillion yuan, equivalent to 10.3% of GDP. If the housing market slows down, housing investment will falter. This will not only directly reduce GDP growth, but will also hurt the economy through lower demand in related industries such as steel, home appliances, and furniture (see Box on the spillover of adjustments in the housing market to the steel market).

On the financial side, as of the end of 2020, mortgage loans to individuals amounted to 34.4 trillion yuan (19.9% of total loans by financial institutions). The scale of funds flowing into the real estate sector should be even larger if we include the loans made to real estate companies by banks and loans via shadow banking (e.g., REITS and trust products). There are fears that if housing prices fall, a large amount of non-performing loans will be generated from banks' loans to the real estate sector. However, this is unlikely to happen as a result of recent restrictions on housing loans, such as the increase in the down payment ratio.

Furthermore, on the fiscal side, local governments' land transfer revenue in 2020 reached 8.4 trillion yuan, accounting for about a quarter of the nation's total fiscal revenue. If real estate prices plummet, land prices will stagnate and land will become harder to sell, which could lead to a significant drop in government fiscal revenue. As a result, public investment, especially in infrastructure, will also be curtailed.

There are concerns that if the housing bubble bursts, China will suffer the same fate as Japan did after the 1990s when it experienced the "lost two decades." However, unlike Japan at that time, which was already a mature and developed country, China today is still in the process of development and is expected to maintain a moderate potential growth rate of 5% for the time being by taking advantage of its "latecomer advantage." China's economy will be able to avoid a prolonged slump even if the housing bubble bursts.

Ⅳ. How Long will the Zero-Infection Policy Last?

In addition to the trends in the housing market, the situation surrounding the prolonged spread of COVID-19 and the government's policy response will be important points to consider in the outlook for the Chinese economy in 2022.

Against the backdrop of the widespread use of vaccinations and the resulting decline in the rate of serious cases and deaths, countries around the world are easing the various restrictive measures they have taken against COVID-19 in order to normalize their economic activities and are seeking to shift to a policy of "coexistence with COVID-19." In contrast, China has maintained a policy of "zero infection" aimed at complete containment of COVID-19. In addition to domestic measures such as large-scale testing, targeted lockdowns, and movement restrictions, China is also implementing thorough border control measures, such as requiring that people entering the country undergo quarantine at designated facilities for two to three weeks.

The global outbreak of the new Omicron variant of COVID-19 that began in November 2021 has forced China to rethink its zero-infection policy. The Omicron variant is highly contagious, and trying to achieve zero infections will require even more stringent measures, such as massive lockdowns, which will cause tremendous damage to the economy. On the other hand, the benefits of implementing a zero-infection policy are small, as hospitalization rates, patients with severe symptoms and deaths caused by the Omicron variant are relatively low.

However, China has two important events coming up: the Winter Olympics to be held in Beijing in February 2022, and the 20th National Congress of the Communist Party of China later in the year, which will decide on the leadership for the next five years and whether General Secretary Xi Jinping will continue to stay in power. In order to make these events successful, it is necessary to maintain a zero-infection policy and control the COVID-19 pandemic. Therefore, the zero-infection policy will have to be maintained until the pandemic is contained, both at home and abroad, at the cost of delaying the normalization of economic activities (Note 2).

BOX Spillover of Housing Market Adjustments to the Steel Market

In China, the demand for steel has been weakening as the real estate market has entered a phase of adjustment. As China is a major steel producer, accounting for more than half of the world's crude steel production, the impact is not limited to the domestic market but also extends overseas through industrial linkages.

Crude steel production in China reached 1.06 billion tonnes in 2020, accounting for 56.7% of the world total (Figure A).

Figure A. World Top 10 Crude Steel Producing Countries (2020)
Figure A. World Top 10 Crude Steel Producing Countries (2020)
Source: Compiled by the author based on data from the World Steel Association.

Domestic demand is the main driver of steel production in China, with steel consumption totaling 971 million tonnes in 2020, with construction accounting for 574 million tonnes (59.1% of the total), machinery for 158 million tonnes (16.3%), and automotive for 53 million tonnes (5.5%) (Figure B). Among them, the construction industry centered on house building accounted for the largest share.

The steel industry has strong upstream linkages with resource industries such as iron ore and energy. China is the largest iron ore importer, accounting for 67.4% of global iron ore imports in 2020 (Note 3). Steel is also the largest electricity-consuming industry and the second largest coal-consuming industry after electricity generation in China.

Figure B. Steel Consumption in China by Industry (2020)
Figure B. Steel Consumption in China by Industry (2020)
Source: Compiled by the author based on China Metallurgical Industry Planning and Research Institute "Press Release on Projection of Steel Demand in China and the World in 2021" (December 21, 2020).

The steel industry is an important industry not only for China but also for the entire world. Reflecting this, the performance of many multinational companies, and thus the economies of many countries, are greatly affected by the supply and demand of steel in China. First, as domestic demand for steel declines, Chinese steel companies will drive exports. As a result, the price of steel will fall in the international market. In addition, the supply and demand of steel in China will have a significant impact on exporters in resource-rich countries through changes in demand for iron ore and energy such as coal, and thus their prices. In fact, the RBA Commodity Price Index, compiled by the Reserve Bank of Australia (RBA), tends to follow housing investment trends in China (both measured year-on-year) with a slight time lag (Figure C).

Figure C. RBA Index of Commodity Prices Moving in Tandem with Housing Investment in China
Figure C. RBA Index of Commodity Prices Moving in Tandem with Housing Investment in China
Source: Compiled by the author based on data from the National Bureau of Statistics of China and the Reserve Bank of Australia.

The original text in Japanese was posted on February 3, 2022.

Footnote(s)
  1. ^ The Johns Hopkins Coronavirus Resource Center.
  2. ^ The U.S. research firm Eurasia Group has ranked China's failure to implement a zero-infection policy as one of the top 10 global risks for 2022, predicting that the country's failure to fully contain COVID-19 could lead to disruption of supply chains and other disruptions to the global economy. (Eurasia Group, "Top Risks 2022," January 2022).
  3. ^ World Steel Association, "World Steel in Figures 2021," 2021.
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