BlackRock Investment Institute

China’s growth challenges go beyond Covid

Oct 17, 2022

By Alex Brazier and Serena Jiang | China’s Communist Party Congress – which kicked off yesterday and will determine a range of key positions in the government and beyond – is unlikely to fundamentally change the political landscape. President Xi Jinping’s opening speech reinforces that view. Our focus is on the economic landscape that will shape the outlook well beyond the conclusion of the congress at the end of the week. The Chinese economy grew apace in the ten years prior to the pandemic, by 7.7% on average each year. But it now faces a set of acute challenges that, in our view, mean it’s entering a stage of significantly slower growth.

Continued Covid disruptions

China has stuck to its strict zero-Covid policy throughout the pandemic, even as the economic costs have increased. Covid lockdowns and restrictions mean the economy is unlikely to grow by much more than 3% this year. Why were the authorities not willing to ease up on Covid restrictions sooner? Too much social and political risk ahead of the Party Congress.


Covid policy is likely to be relaxed gradually at some point after the congress. We don’t think all the restrictions will be removed in one fell swoop given the relatively slow uptake of vaccines among the elderly, limited natural immunity in the population, the approaching winter, a still-evolving virus and the ongoing development of new domestic vaccines and medicine. Overall, we think looser Covid controls will boost growth somewhat next year, but we should still expect Covid-related disruptions to hold back the level of activity.


Yet the big focus on Covid-related ups and downs in activity ignores another underlying issue that, we think, will significantly challenge Chinese growth next year – and beyond.

Fading demand for Chinese exports

A huge boost to China’s economy in recent years is now fading. During the pandemic, China was able to take advantage of a sudden splurge on goods by locked-down consumers in developed markets. As other Asian manufacturers were plagued by Covid shutdowns, China kept its factories open and operating thanks to its strict Covid controls, which largely kept outbreaks contained. It churned out goods to meet that skyrocketing foreign demand. Result? Its export volumes surged by an average of 10% a year in 2020 and 2021 (or 17% in nominal terms – i.e. before being adjusted for inflation).[1] That’s more than double the average growth rate in the three years leading up to the pandemic.


But demand for goods is starting to slow down again as the West emerges from pandemic restrictions and people prefer to spend on eating out, travelling and socializing again, or are tightening their belts amid the cost-of-living squeeze. Plus, other Asian countries are ramping manufacturing back up and providing alternatives to Chinese-produced goods.


China’s export growth has already been slowing markedly since July.[2] We think the volume of exports could actually shrink by 6% on average in 2022 and 2023 (translating into nominal export growth of just 3.0%).[3] So, instead of making a positive contribution to overall economic growth (of 1.8 percentage points in 2020/21), exports could make a negative contribution of 1.1 percentage points this year and next. See the Exports: A positive becomes a negative chart below.


Losing that huge growth driver will make maintaining overall economic growth quite the challenge. All else equal, economic growth next year would be a substantial 2.9 percentage points slower overall. Given the loss of export demand, the only way to achieve a steady growth rate of 5% (roughly in line with the authorities’ target) in 2022 and 2023 would be to almost double the growth rate of domestic demand. See the chart.

Chart shows actual, forecast and implied contributions to GDP growth 2020-2023

Sources: BlackRock Investment Institute, with data from Haver Analytics, October 2022. Notes: The left bar shows the percentage-point contribution to GDP growth of goods exports (yellow) and of all other sources (orange). The right bar shows the expected percentage-point contribution to growth from goods exports (yellow) and the implied percentage-point contribution to growth from other sources that would therefore be needed to achieve an overall GDP growth rate of 5%.


Will Chinese policymakers try to boost growth?

Chinese policymakers are concerned by the extent of the slowdown in exports and have implemented policies that stimulate domestic spending and investment. But as with Covid policy, they were reluctant to take any drastic measures in the lead up to the congress.


That could change afterwards but we shouldn’t expect too much. Why? We don’t expect a major change in the political landscape and the current authorities have shown themselves to be pretty cautious about implementing policies to boost growth, unlike their predecessors who went all out during the financial crisis. In recent years, the government has typically aimed for the minimum possible support as it worries about pro-growth policies resulting in too much debt, artificially inflated asset prices or greater income inequality. When facing a trade-off between growth today and risks that could have a big effect tomorrow, the government has prioritized future stability.


Take real estate. The authorities have recently taken measures to prop up this sector and we could see more.[4] But we think they’ll be fairly restrained because they won’t want to artificially inflate real estate prices and risk future instability.


Another example is their approach to the currency. The authorities have allowed the Chinese renminbi to depreciate this year. But only by 3.5% by the end of September, when compared to a basket of other currencies after adjusting for inflation differences (the real effective exchange rate). We think the slump in demand for Chinese exports, coupled with higher U.S. interest rates (which make Chinese investments less attractive for investors), would ultimately warrant a depreciation of twice that seen this year. Further depreciation could help to cushion the blow to exports as Chinese goods would become cheaper for overseas buyers. But we think the authorities are reluctant to see further sharp depreciation against the dollar – for example, because of financial stability concerns given borrowing by Chinese firms in U.S. dollars.

Limited room to boost growth anyway

More fundamentally, the authorities don’t have as much room to boost growth aggressively even if they wanted to. Previous periods of slower growth, like in 2000, 2008 and 2015, came alongside rapidly increasing productive capacity, which drove inflation down. That’s not the case this time – which suggests that China’s potential output (the amount it can produce before inflation starts to surge) is lower now.


Covid controls are reducing potential output today. While they might be eased, we still think the potential growth rate of the Chinese economy might have fallen below 5% and could fall further to around 3% by the turn of the decade.[5] Why? Most importantly, the working age population, having grown rapidly, is now shrinking. See the A shrinking working-age population chart. Fewer workers mean the economy cannot produce as much without generating inflation, unless productivity growth accelerates. But we think international trade and tech restrictions, as well as tighter regulations on companies operating in China, will dampen productivity growth.

Chart showing actual and forecast growth in china's working age population, 1980-2040

Sources: BlackRock Investment Institute and United Nations, October 2022. Notes: The chart shows actual China’s working-age population growth and the UN’s April 2022 median variant forecast to 2040. Working age is defined as 15-64 years.


Global knock-on effect of slower Chinese growth

Putting all this together, we don’t think Chinese policymakers will take aggressive measures to boost growth. It’s possible the removal of Covid controls could give a bigger-than-expect boost if it happens more quickly, but there’s no clear indication of pace yet. Looking through the Covid ups and downs, we think the slowing of demand, and grudging policy offsets as supply growth slows, means growth will average significantly below pre-pandemic rates in coming years.   


That will have a knock-on effect on the rest of the world. In the past, when countries faced a slowdown, they could still rely on Chinese consumers and companies to buy up their cars, chemicals, machinery, fuel – even as consumers at home tightened their belts. And they could rely on China to continue supplying an abundance of cheap products as China’s rapidly growing working population enabled it to keep production costs low.


Not so anymore. Recession is looming now for the U.S., UK and Europe. But this time, China won’t be coming to its own, or anyone else’s, rescue.

[1] The figure for nominal export growth comes from the National Bureau of Statistics of China and we estimate real export growth using the export price index.

[2] China’s exports contracted by 1.7% in July and 5.9% in August sequentially after seasonal adjustment.

[3] Based on the assumption that Chinese exports relative to world trade fall back to their pre-Covid trend path.

[4] Such as lower mortgage rates or fewer purchasing restrictions

[5] This assumes a modest slowdown in productivity growth alongside the shrinking of the working-age population.

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