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Article31 Jan 2023

China Reopening: This Time It’s Different

A new report by Citi Research’s David Lubin looks how China’s reopening and its impact on the wider world may be different this time around.

China’s reopening will shape emerging markets this year. But this time its effects will be different than in the past.

The big Chinese economic recoveries of recent years have been characterised by two features above all: they’ve been stimulus-driven and investment-led. In other words, past recoveries have relied on large amounts of policy support for infrastructure and real estate.

That was most obvious in the recovery that followed the Global Financial Crisis and the one that followed China’s slump of 2015.

China’s 2023 recovery will be different, Citi Research analysts says, in the sense that this one is probably best-described as a ‘spontaneous’ recovery (not stimulus-driven), which will see the biggest effects on the services and consumption (and not investment).

For this reason, Citi Research analysts say the impact of China’s recovery on the rest of the world might be more muted than in the past.

 

The heyday of China’s dominance of the global investment cycle is likely to be over…

. …and a credit stimulus aimed at supporting an investment-led recovery is not really going to be part of China’s story this year

Figure 2. The heyday of China’s dominance of the global investment cycle is likely to be over… Source: Citi Research If you are visually impaired and would like to speak to a Citi representative regarding the details of the graphics in this document, please call USA 1-888-800-5008 (TTY: 711), from outside the US +1-210-677-3788. Figure 3. …and a credit stimulus aimed at supporting an investment-led recovery is not really going to be part of China’s story this year Source: Citi Research If you are visually impaired and would like to speak to a Citi representative regarding the details of the graphics in this document, please call USA 1-888-800-5008 (TTY: 711), from outside the US +1-210-677-3788.

© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission.

Source: Citi Research

© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission.

Source: Citi Research

 

While the opening of China’s borders obviously benefits the traditional recipients of China’s tourism largesse, the likely deterioration in both the current and capital accounts of China’s balance of payments will produce more ambiguous effects on the CNY than seen so far.

So, while China’s recovery is undoubtedly a big theme both for EM and the world as a whole, it’s important to recognise that its effects will be subtly different from the past.

The pattern of Chinese growth in the decade following the GFC gave it a huge role in shaping global investment spending, and that role is waning. China’s growth model has been resolutely investment-driven for many years, which means investment spending shaped Chinese GDP to a large extent – more than 40% of China’s GDP growth came from gross capital formation in the years 2010-2019. It also led to China’s decisive role in shaping the global investment cycle: during that same decade, China’s investment spending accounted for over one-half of global investment growth.

China’s 2023 reopening is more akin to a spontaneous recovery rather than the policy-driven recoveries seen in the past. To be sure, there has clearly been a policy pivot in recent weeks, but it’s not really a pivot towards looser fiscal and monetary policy. Rather, the pivot that’s most visible these days is a pivot away from ‘ideology’ towards ‘pragmatism’.

This ‘pivot to pragmatism’ is a bit different than the macro-policy pivots that have been evident in the past. Substantial fiscal expansion is not expected this time around, not least because one of the motivations for this economic reopening is an anxiety about the build-up of debt in recent years. Moreover, the fact that the China-US interest rate differential is now negative – 3m USD interbank rates are now nearly 200bp higher than in China – creates disincentives to conduct loose monetary policy.

Another reason why this Chinese recovery may not follow the stimulus-led playbook of past recoveries is the pursuit of economic self-reliance. The first chart below illustrates this with respect to energy by showing that China’s net imports of energy seem to have peaked in 2017. That peaking of import dependence might well be sustained given the fact that China’s production of non-fossil fuel energy seems to be advancing apace: production of renewable and nuclear energy in China has been in excess of consumption of those energy sources every year between 2014 and 2020 (the last year for which data are available).

 

China’s net energy imports seem to have peaked in 2017 thanks to rising domestic production of renewables and nuclear…

…and given China’s big increase in net food imports, raising domestic agricultural productivity is an important objective

 

Figure 6. China’s net energy imports seem to have peaked in 2017 thanks to rising domestic production of renewables and nuclear… Source: Citi Research If you are visually impaired and would like to speak to a Citi representative regarding the details of the graphics in this document, please call USA 1-888-800-5008 (TTY: 711), from outside the US +1-210-677-3788. Figure 7. …and given China’s big increase in net food imports, raising domestic agricultural productivity is an important objective Source: Citi Research If you are visually impaired and would like to speak to a Citi representative regarding the details of the graphics in this document, please call USA 1-888-800-5008 (TTY: 711), from outside the US +1-210-677-3788.

© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission.

Source: Citi Research

© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission.

Source: Citi Research

 

A final question worth raising about China’s reopening is its balance of payments consequences, which in due course might affect the RMB. China’s current account balance has improved dramatically since 2019, for reasons including strong merchandise exports, weak import demand, and less tourism. By Q3 last year the surplus had exceeded 3% GDP for the first time since 2015, when the surplus was similarly boosted by weak growth. As Chinese tourists venture out, and import demand increases with the recovery, the current account surplus will certainly fall from the c.$400 bn annualised level it reached late last year. Much of the erosion of the surplus will come from net travel, which drained more than $200 bn from the current account in 2019. What is particularly noteworthy, though, is the relationship between tourism outflows and apparent capital outflows proxied by the errors and omissions line of the balance of payments

Citi Research analysts say no one really has much clarity about the nature of this relationship, but that it seems intuitive that the opportunity to leave the country creates opportunities to get capital abroad.

And in the three years since the Chinese were last able to travel abroad easily, a number of factors have arguably increased the incentive to diversify wealth offshore. Not only has the China-US interest rate differential turned negative, as mentioned earlier, but it is also the case that real estate is no longer a reliable store of wealth domestically.

Who benefits from an increase in China’s consumer imports? Aside from the most obvious effects of an increase in Chinese outbound tourism, a consumer-driven acceleration in Chinese activity might have the most favourable effects, by a process of inertia, on the countries that already depend most on selling consumer goods to China (Citi Research analysts haven’t investigated services, where data are much less good). This is illustrated in the chart below, which suggests that the biggest benefits will be intra-regional.

 

The biggest dependence on Chinese consumer imports is naturally located in Asia

Figure 10. The biggest dependence on Chinese consumer imports is naturally located in Asia Source: Citi Research, Haver Analytics, IMF If you are visually impaired and would like to speak to a Citi representative regarding the details of the graphics in this document, please call USA 1-888-800-5008 (TTY: 711), from outside the US +1-210-677-3788.

© 2022 Citigroup Inc. No redistribution without Citigroup’s written permission.

Source: Citi Research, Haver Analytics, IMF

 

Another recent report by Citi Research’s Johanna Chua points to a new theme this year described as the Return of the “Globalist Xi”.

Due to both economic and geopolitical imperatives, China seems to be stepping up its charm offensive to rebuild economic and diplomatic ties:

  1. A “Globalist Xi” could be laxer about cross-border travel;
  2. be more willing to accommodate outward direct investment of Chinese companies; and
  3. be more welcoming of FDI/MNCs, especially as it seeks to boost high-tech capacities.

The first two would likely disproportionately benefit ASEAN, but the latter is unlikely to alter the production diversification drive as other parties - US/West - are not becoming more “globalist”.

A “Globalist Xi” could become more engaged with multilateral sovereign debt restructurings: Sri Lanka will be key to watch.

In sum, while China’s reopening is of course a hugely significant event, market participants might need to adjust their expectations of its impact. For more information on this subject, please see the full reports here: Emerging Markets Economic Outlook & Strategy - The meaning of China’s reopening and Asia Economic Outlook & Strategy - Updating Our 2023 Outlook – Calibrating Some Narratives

For further reading on how China’s policy is evolving, see China’s Inward Turn, Citi’s recent GPS report

Citi Global Insights (CGI) is Citi’s premier non-independent thought leadership curation. It is not investment research; however, it may contain thematic content previously expressed in an Independent Research report. For the full CGI disclosure, click here.

 

 

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