Is Xi Jinping about to do a U-turn on his damaging COVID policies?

A wave of speculation that China’s harsh zero-COVID policies might be lifted swept through China’s financial markets on Monday. That might be wishful thinking but the vehemence of the response by investors underscores how damaging the policies have been to China’s economy and companies.

The speculation was sparked by social media posts that suggested that a committee had been formed by Beijing to develop plans for an exit from zero-COVID. It sparked an immediate turnaround in the Hong Kong and mainland stockmarkets, which had been trading down to their lowest levels in a decade and a half.

Xi Jinping reaffirmed his commitment to zero COVID at the National Congress last month but he is under pressure to change course.Credit: Getty Images

The Hang Seng index closed up more than 5 per cent, the Shanghai Composite 2.6 per cent and the CSI 300, which tracks the larger stocks listed on the Shanghai and Shenzhen exchanges, was up 3.6 per cent. It had fallen almost 30 per cent since the start of the year before Monday’s action.

China’s currency was also boosted slightly from near 15-year lows as the speculation circulated. Other Asian financial markets also responded positively to the reports.

If there were to be a change in China’s rigid approach to COVID outbreaks it would be a surprise, since Xi Jinping recommitted to the policy at the Communist Party’s National Congress last month that extended his tenure for an unprecedented third term.

The pressure for change to a policy that has wreaked havoc within China’s economy is, however, mounting even as signs that tolerance for the harsh rolling lockdowns within China’s population is waning.

Images of workers scrambling over fences at Foxconn’s iPhone campus in Zhengzhou, fleeing on foot to avoid a lockdown at the weekend, and the locking in of visitors to Shanghai Disneyland on Monday until they were tested for COVID-19 – after one COVID case was identified – illustrate how extreme and disruptive the policies are.

While the authorities no longer announce large-scale lockdowns, an indication of how impactful they are can be seen in air travel data cited by Bloomberg, which said that of more than 12,250 flights scheduled nationally on Monday only 4234 were successfully completed. More than 8000 were cancelled.

The degree of disruption to the wider economy was underscored by China’s official purchasing manufacturers index (PMI) data released on Monday that showed its manufacturing sector is shrinking, with the PMI reading falling from 50.1 per cent to 48.7 per cent last month. Anything less than a reading of 50 says the sector is contracting.

The composite PMI, which includes both manufacturing and services, also indicated contraction, with the index falling from 50.6 per cent in September to 48.7 per cent last month as lower real estate and construction activity and weaker retail sales (in what has historically been a strong month for retail spending) impacted activity.

With COVID case numbers rising again and spreading through some of China’s key industrial centres this month economic activity might be even more severely impacted.

China’s sharemarkets bounced on speculation a committee had been formed by Beijing to develop plans for an exit from zero-COVID.Credit: Bloomberg

The pressure on Xi to execute what would be a somewhat embarrassing about-face and significantly relax his zero-COVID approach can only mount if China’s already weak economic performance slows further.

Officials have backed away from their target of 5.5 per cent growth in the economy this year, with GDP growth just above three per cent looking more likely. By China’s standards that would be anaemic.

The two biggest depressing influences on China’s economy are its stance on COVID and the continuing implosion of a property sector that used to account for about 30 per cent of its GDP.

The slump in property sales and prices and investment in the sector is continuing despite a range of interventions by the central and local government authorities, including interest rates cuts, subsidies, reduced down-payments and income tax rebates to try to stimulate activity.

The pressure for change to a policy that has wreaked havoc within China’s economy is, however, mounting even as signs that tolerance for the harsh rolling lockdowns within China’s population is waning.

Local governments had been buying new homes from developers to try to lift activity levels in a sector that generates more than 40 per cent of their non-Beijing income until a recent crackdown by Beijing, which was concerned that the practice would increase the indebtedness of already over-leveraged local governments.

While the residential market remains recessed – prices fell again in October for the fourth successive month and sales by floor area were about 20 per cent lower in October than for the same month last year – the development end of the market has yet to stabilise.

Hardly a day goes by without another developer failing to make scheduled interest and/or principal repayments on their borrowings, or warning of a likely failure to pay.

Most disconcerting, developers with credit enhancements (quasi guarantees) from the state-owned China Bond Insurance Co are missing payments.

CIFI Holdings Group, China’s 15th-largest developer, failed to make a payment last month on a Hong Kong dollar convertible bond and warned that it might also default on its offshore debt. CIFI is one of the select group of developers that has China Bond support.

On Monday another developer, Greenland Holding Group, said it would probably default on its dollar bonds this month. Greenland is partly owned by local governments.

The bonds of even the largest developers with investment-grade credit ratings are trading at big discounts to their face value while lesser-rated developers’ bonds are trading at fractions of their face value.

China’s zero-COVID policies continue to damage the vulnerable domestic economy. Credit: Getty

Despite a range of attempts to prop up the sector, which was completely destabilised by the restrictions on leverage that Beijing imposed without much notice in late 2020, the authorities have failed to stabilise it.

With several hundreds of millions of US dollar-denominated debt scheduled to fall due over the next 12 months the condition of the industry could, and probably will, get even worse without some large government interventions.

Until the authorities can reduce the impact of their COVID policies and put a floor under the property sector it will be nigh-on impossible for China to generate the economic growth rates necessary for political stability, let alone the growth required to fund Xi’s ambitious geopolitical and technological ambitions.

The state of the global economy, threatened by soaring inflation rates, surging interest rates, the war in Ukraine and its impact on energy supply and prices and a consequent slowing of economic growth – with potential recessions in Europe, the US and elsewhere – means exports, even if there were fewer or less destructive COVID impacts on industrial production, are unlikely to provide much of a safety valve.

The pressure on Xi, fresh from his triumph at the National Congress, to do something to alleviate the effects of his own ill-conceived policies, can only mount.

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