How China’s COVID surge will affect the world economy

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It would be a gross understatement to say China is ill-prepared for President Xi Jinping’s recent abrupt abandonment of his zero-COVID policy. With a large part of the population inadequately vaccinated, COVID is spreading like wildfire across the country. More than half the passengers on a China-to-Italy flight this week tested positive.

Leaked notes from Chinese official estimates reveal that over the past 20 days as many as 250 million people might have been infected with the virus. It’s now leading to widespread workplace absenteeism and a sharp drop in consumer and investor confidence in the economy.

There’s never a good time for COVID chaos to strike China, the world’s second-largest economy and until recently the world’s main engine of economic growth. But it’s a particularly bad time for such a shock.

China’s economy was already in a weakened state thanks to the zero-COVID policy and the bursting of its outsized property and credit-market bubble. Chinese economic growth for 2022 is likely to have been only some 2.75% — half the government’s 5.5% growth target — per the World Bank.

This is only half the government’s 5.5% growth target — per the World Bank.
Chinese economic growth for 2022 is likely to have been only some 2.75%.
AP

Beijing’s new economic shock is coming when the rest of the world economy is headed to recession as its central banks slam on the monetary-policy brakes to regain control over multi-decade-high inflation.

With the virus widely expected to spread exponentially at the end of January as Chinese workers head home to celebrate the lunar New Year, expect a strong Chinese policy response to prevent the economy from a major slump. This would seem to be especially the case considering China’s ongoing property-market bust and its dismal export prospects at a time of global economic weakness.

This makes it all too likely that in much the same way as in 2020 the Federal Reserve turned on the monetary-policy spigots and the US government engaged in its largest peacetime budget stimulus on record in response to the COVID-induced economic recession, the Chinese government will do the same in response to its new COVID economic crisis. Lower interest rates could further weaken the Chinese currency and encourage Chinese capital flight.

The good news for the rest of the world economy is that with China the globe’s largest consumer of internationally traded commodities, its renewed COVID outbreak could mean lower commodity prices in general and lower international oil prices in particular.

Another way the Chinese pandemic might ease world inflationary pressures is that it could result in lower Chinese export prices. This would especially be the case should China’s COVID-induced slowdown lead to lower domestic prices and a weaker currency.   

The bad news is that China’s renewed COVID-related economic problems could deliver a body blow to an already-fragile world economy in a number of ways. As Apple has recently warned, China’s economic troubles could cause renewed supply-chain disruptions that could curtail production. Meanwhile, reduced Chinese import demand might be very problematic, especially for China’s Asian trade partners, while lower international commodity prices could accelerate the pace of emerging-market debt defaults.

Half of the passengers on a flight from China to Italy tested positive.
Leaked notes from Chinese official estimates reveal that over the past 20 days as many as 250 million people might have been infected with the virus.
AP

At a time of global financial-market fragility, the last thing we need is another leg down in the world economy. In the context of rising world interest rates to contain inflation, such a leg down could put further pressure on world equity prices and add to strains in the world credit market. Yet that is exactly what could be in store for us during the first half of 2023 as the Chinese COVID crisis intensifies.

All of this underlines the need for a humble and nimble Federal Reserve. Should the global economy indeed take another leg down and should US and world financial-market pressures intensify, the Fed should stand ready to pivot away from its newfound monetary-policy religion and start reducing interest rates.

American Enterprise Institute senior fellow Desmond Lachman was a deputy director in the International Monetary Fund’s Policy Development and Review Department and the chief emerging market economic strategist at Salomon Smith Barney.

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