The worst of supply chain disruptions in China is over: Morgan Stanley

THE worst of the supply chain disruptions in China as a result of the Covid-19 pandemic and lockdowns appears to be over, but the road to recovery will likely be slow and bumpy, says Robin Xing, Morgan Stanley’s chief China economist.

Speaking at a virtual media briefing on Friday (May 20), Xing said “we have seen the light at the end of the tunnel”.

“We think the second quarter in China will see a quarter-on-quarter contraction in gross domestic product (GDP) growth amid the Covid and the lockdowns. Starting from the third quarter, we see a pickup in the supply side of production activities with the new approach of handling Covid before a Covid-zero exit strategy,” said the economist.

China is planning to set up Covid-19 testing booths within a 15-minute walk in all major cities, as regular negative nucleic acid results become a requirement for going to school, work, shopping or eating out under the “dynamic zero tolerance” approach to Covid-19, and ahead of its crucial Party Congress in October/November. Hence, a more visible rebound from the fourth quarter is expected. Morgan Stanley’s forecast of a 4.2 per cent on-year growth for China this year is predicated on no further extended lockdowns of major cities, and an expected exit from its zero-Covid stance in November. Its bear case forecast is 3.5 per cent, if China exits from zero-Covid in June 2023. Its bull case GDP forecast is 4.9 per cent, if China exits from zero-Covid in June this year.  

Xing reckoned China will exit from its zero-Covid strategy by the end of this year. But first, China must address the weak links like vaccination, its healthcare system, allocation of resources and changing people’s mindset on Covid.

The last 2 months have seen progress made in the vaccination of those over 70 years old, and a greater share of the population taking the third booster shot for Covid-19. Based on this pace of vaccination, in about 4 to 5 months, China should be able to achieve an 80 per cent vaccination ratio for the third jab.

Beijing’s Covid lockdowns are hurting domestic demand probably more than exports, with more than 20 per cent of China’s cities under some kind of mobility restrictions, Xing said. 

“Consumption is the main reason why growth is decelerating so much but for the supply side, we do believe we may have seen the worst,” he said.

Shanghai, China’s financial hub with more than 28 million people, remains in lockdown for almost 2 months, though more residents are recently allowed to go out to shop for groceries. In Beijing, while there is no city-wide lockdown, travel remains restricted for its 21 million people. 

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Except for Shanghai, freight is back to 85 per cent of pre-Omicron levels, which implies that China’s Covid management is effective.  

Before China unveils an exit strategy from its zero-Covid policy, Xing said Beijing needs to provide more stimulus for the economy. He believes there is still room for the government to increase the size of stimulus to get the economy back on track.

He noted that China’s fiscal stimulus for 2022 is still too small, at about half of the size of what they did in 2020. 

“For example, in 2020, they expanded the fiscal deficit by more than 5 percentage points of GDP. But this year it’s 2.5 per cent,” Xing said.

China has cut its interbank rates and on Friday, shaved 15 basis points to the 5-year  loan prime rate (LPR), which banks normally charge their best clients, to 4.45 per cent. But the cuts have fallen short of expectations, compared to 2020 when Covid-19 first broke.  

On the weakening of the yuan over the past 2 months, Xing believes Beijing will allow the yuan to play a stabiliser role, but also intervene from time to time to prevent any disorderly depreciation of the currency.

One US dollar may be worth 6.8 yuan by year end, Xing predicts. It was trading at 6.72 yuan on Friday.