• China’s Zero-COVID policy comes with big economic and political costs, but there is no sign the government will change direction any time soon.
  • It’s a political year for China with the upcoming Party Congress in the fall, where President Xi is expected to secure a third term as president—Xi cannot risk a significant outbreak and that’s the dynamic driving the policy.
  • China is making modest moves to address the economic slowdown—support for SMEs, monetary policy easing, and lessening scrutiny on the tech sector—but the Zero-COVID could have long-term implications on investment decisions.
  • We are starting to see some different views on Zero-COVID emerge particularly from Premier Li Keqiang who is promoting efforts to support SMEs and entrepreneurs as China faces a slowing economy.

“Our prevention and control policies can withstand the test of history; our measures are scientific and effective. We have won the battle to defend Wuhan, we can also win the battle to defend Shanghai,”

– Chinese Communist Party Politburo Standing Committee statement, May 5, 2022

Zero-COVID Hangs Tight

The Chinese government is maintaining its Zero-COVID policy despite a rising economic toll and growing domestic and international criticism. As a full lockdown in Shanghai continues, Beijing teeters on the edge, and targeted lockdowns across other economic centers impair inland supply chains, it is looking unlikely that China will hit its “around 5.5%” growth target set in March. China’s economic downturn is also threatening global growth prospects at a time when the international economy is already facing headwinds from the Russia-Ukraine crisis and ongoing inflationary pressures.

Yet China’s government has tripled down—a May 5 Politburo statement warned against criticism of the policy. With the twice-a-decade 20th Party Congress in the fall, we expect the policy to continue through at least the end of this year. Mounting economic and social pressure may press the government to look for opportunities to ease the policy to maintain overall stability. One option would be approving foreign MRNA vaccines and launching a mass vaccination campaign. Though China’s drug regulator approved the Pfizer therapeutic in February, before the outbreak, it is unclear if the government would take a similar step on vaccines where they have domestic alternatives. But without scaling back the COVID policy or ramping up vaccinations, it is hard to envision an economic rebound, which comes with potential political implications.

 

Short Term Economic Slow Down is Tolerable, COVID is Not

President Xi Jinping has hung his hat on the success of the policy to-date—China was the first major economy to bring COVID under control in 2020, and the only major economy to record growth that year. Relaxing the policy would be politically risky for Xi as he moves toward a third term in the fall, breaking with recent precedent. Despite growing criticism and threats of social unrest, the prospect of high deaths rates, particularly among China’s large elderly population who are largely unvaccinated. is a far greater risk. Only 50% of people over 80 are fully vaccinated and only 20% of that age group are boosted.

The Chinese government has been clear that maintaining stability—political, social, economic—is the top priority heading into the 20th Party Congress which will see a significant leadership turnover under Xi. After announcing an ambitious growth target in March, before the Shanghai lockdown, the government is now pivoting to a “stability first, growth second” strategy.

A short-term economic downturn is viewed as more acceptable for overall stability—indeed the government has already prepared for more moderated, quality growth. However, amid growing concern for the economy, a tone shift appears underway. Fully disbanding the COVID policy is politically unlikely, but more policies to support the economy should be expected.

 

Nonetheless, Moves to Shore Up the Economy

The government said in April they will stick with the “around 5.5%” growth target but gave no clear indication of how to hit that objective—spelling continued regulatory and policy uncertainty. Full-blown economic stimulus is unlikely due to concerns of long-term fiscal sustainability, but a push by Premier Li Keqiang to stem the economic downturn is underway.

A top concern of Premier Li’s is fending off mass layoffs. A focus has been ramping up support for small- and medium-sized enterprises (SMEs), which account for 80% of China’s employment and 60% of its tax base. Other efforts include a (likely temporary) pause on new restrictions on the technology sector, which has been under scrutiny but is a major employer and growth driver, and modest monetary policy easing. Li has also encouraged local governments to help hundreds of manufacturers and employers get back to work in closed-loop systems, including many foreign companies.

Despite these efforts, the Zero-COVID policy is weighing on medium and long-term business and investment strategies. U.S.-China trade tensions and the initial wave of COVID had companies looking at the overconcentration of supply chains in China, but there was no significant movement out of China. New COVID lockdowns and the Ukraine crisis have given added impetus to building resilience and redundancy into global supply chains.

While a business climate report conducted before the Shanghai lockdown indicated China remains a top global investment priority, a follow up survey in May shows rapidly deteriorating confidence due to the COVID policy. Companies have decreased revenue projections, and many are pausing investments. China will remain an important global market in the long-term as most companies take an “in China, for China” approach. But there will be some movement as companies hedge supply chain risk through diversification.

 

The Political Fallout

Since the beginning of the pandemic in 2020, over 1,000 local officials have been sacked or disciplined for failing to control outbreaks, including more than 70 in the past few months. President of the EU Chamber of Commerce in China Joerg Wuttke recently said: “You won’t get kicked out of your job if the economy in your area is doing poorly on average – but you will lose your job if you have COVID in your city.” That sentiment was recently echoed by a former top economic policy maker, Yang Weimin.

The political and economic fallout from Shanghai, will be important to watch leading up to the Party Congress. Shanghai’s top Party official, Li Qiang, is also a close associate of President Xi. He has been considered a top contender to join the Politburo Standing Committee, the Party’s highest organization, and potentially takeover from Premier Li Keqiang as number two. It is uncertain where he will now land.

The composition of the top political body is a key indicator of the President’s political standing, and more importantly, of the policy direction for the next five years. Amid growing economic headwinds, the political jockeying and upcoming leadership changes will be pivotal as the government works to bring COVID under control and keep the economy on track in this political year.

Contributions from: Camille Bryan and Chynna Hawes