China

166 _

China Following the steepest quarterly collapse on record in the first quarter, GDP will fall by around 3.7% in 2020 if there is a second virus outbreak later in the year and by a percentage point less if a further outbreak is avoided, before rebounding in 2021. The COVID-19 outbreak disrupted economic activities around the country and many businesses remain shut even though lockdown measures have been lifted. The pandemic triggered an increase in precautionary saving and eroded consumer confidence, weakening short-term consumption prospects. Infrastructure investment will hold up growth amid collapsing private investment and foreign demand. If the virus outbreak returns, the second shock to the economy will be much smaller than during the first outbreak, which occurred during the holiday season when most people were away and thereby were not able to return to work due to lockdowns.

Lockdown measures have been lifted, but tourism-related industries and firms heavily dependent on foreign demand are far from fully resuming activities. As smaller firms are over-represented in these activities, they are hit disproportionately, pushing up unemployment. Rolling over of loans and tax exemptions may help those that are eligible, but many rely on shadow banking for financing and need to pay fixed costs even without generating revenues. Greater support to shoulder their fixed costs is needed. Workers laid off or put on unpaid leave should receive social assistance irrespective of their residence. The out-of-pocket share of health costs should be reduced. Infrastructure investment should be channelled to urban transit systems and rural roads where the social return is high, in particular to reduce climate risks.

The COVID-19 outbreak exposed vulnerabilities and left the economy with scars The COVID-19 virus was first identified in Wuhan in Hubei province. Following the SARS outbreak in 2002-03, disease control has been strengthened, but the system continues to be subject to multi-level governance problems, leading to a stage where only a stringent form of lockdown could effectively stop the spread of the virus, at the cost of thousands of human lives.

China 1 The recovery will be moderate Index 2019Q4 = 100, s.a.

110

Trade growthš has collapsed

Real GDP

Single-hit scenario

Exports

Imports

Double-hit scenario

Y-o-y % changes 50 40

105

30 100

20

95

10 0

90

-10 85 80

-20 2019

2020

2021

0

0

2018

2019

-30

1. Data are in nominal terms. February 2020 growth rate refer to the cumulated January-February growth over the same period of last year.

Source: OECD Economic Outlook 107 database; and CEIC. StatLink 2 https://doi.org/10.1787/888934139157

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China: Demand, output and prices (double-hit scenario) 2016

2017

Current prices CNY trillion

China: double-hit scenario GDP at market prices Total domestic demand Exports of goods and services Imports of goods and services Net exports1 Memorandum items GDP deflator Consumer price index General government financial balance2 (% of GDP) Headline government financial balance3 (% of GDP) Current account balance (% of GDP)

2018

2019

2020

2021

Percentage changes, volume (2015 prices)

74.6 73.0 14.6 12.9 1.7

6.9 6.0 11.3 6.9 1.1

6.7 7.2 3.7 5.7 -0.2

6.1 5.9 2.0 0.3 0.4

-3.7 -3.3 -4.6 -2.6 -0.5

4.5 4.1 4.4 2.2 0.5

_ _ _ _ _

4.3 1.5 -3.1 -2.9 1.6

3.5 1.9 -3.1 -2.6 0.2

1.6 2.9 -3.7 -2.8 1.0

1.4 4.0 -7.6 -4.0 0.6

1.6 2.3 -7.6 -3.3 0.8

1. Contributions to changes in real GDP, actual amount in the first column.

2. Encompasses the balances of all four budget accounts (general account, government managed funds, social security funds and the state-owned capital management account).

3. The headline fiscal balance is the official balance defined as the difference between revenues and outlays. Revenues include: general budget revenue, revenue from the central stabilisation fund and sub-national budget adjustment. Outlays include: general budget spending, replenishment of the central stabilisation fund and repayment of principal on sub-national debt.

Source: OECD Economic Outlook 107 database.

StatLink 2 https://doi.org/10.1787/888934137485

China 2 Shadow banking continues to contract amid solid formal credit growth

Private investment has plummeted Year-to-date data Y-o-y % changes 10

Y-o-y % changes 20

5

15

0

10

-5 5 -10 0

-15

-5 -10 -15

-20 -25

Bank credit Core shadow banking itemsš

2017

2018

2019

0

0

2017

2019

-30

1. Core shadow banking items include entrusted loans, trusted loans and undiscounted bankers' acceptance.

Source: CEIC. StatLink 2 https://doi.org/10.1787/888934139176

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168 _

China: Demand, output and prices (single-hit scenario) 2016

2017

Current prices CNY trillion

China: single-hit scenario GDP at market prices Total domestic demand Exports of goods and services Imports of goods and services Net exports1 Memorandum items GDP deflator Consumer price index General government financial balance2 (% of GDP) Headline government financial balance3 (% of GDP) Current account balance (% of GDP)

2018

2019

2020

2021

Percentage changes, volume (2015 prices)

74.6 73.0 14.6 12.9 1.7

6.9 6.0 11.3 6.9 1.1

6.7 7.2 3.7 5.7 -0.2

6.1 5.9 2.0 0.3 0.4

-2.6 -2.2 -3.8 -1.8 -0.5

6.8 6.3 5.2 2.4 0.6

_ _ _ _ _

4.3 1.5 -3.1 -2.9 1.6

3.5 1.9 -3.1 -2.6 0.2

1.6 2.9 -3.7 -2.8 1.0

1.4 3.8 -7.2 -3.6 0.6

1.6 1.9 -6.2 -3.2 0.9

1. Contributions to changes in real GDP, actual amount in the first column.

2. Encompasses the balances of all four budget accounts (general account, government managed funds, social security funds and the state-owned capital management account).

3. The headline fiscal balance is the official balance defined as the difference between revenues and outlays. Revenues include: general budget revenue, revenue from the central stabilisation fund and sub-national budget adjustment. Outlays include: general budget spending, replenishment of the central stabilisation fund and repayment of principal on sub-national debt.

Source: OECD Economic Outlook 107 database.

StatLink 2 https://doi.org/10.1787/888934137504

As the lockdown of the epicentre was announced on the eve of the Chinese New Year, holidays were extended by two weeks in most parts of the country. The neighbourhood committee system was crucial in administering rigorous testing, tracking of contacts and isolating of confirmed and suspected cases. The distribution of high-quality medical resources is very uneven across the country, with most of them in the largest cities, thereby forcing rural areas to self-shut to avoid the virus. Because of the stringent measures, nearly half of China’s counties did not have a single COVID-19 case. From mid-February, activities started resuming gradually, while Hubei province remained under lockdown for 2 months and Wuhan for 2.5 months.

Economic activity experienced the sharpest quarterly fall on record Economic activity fell by 6.8% in the first quarter (y-o-y), driven mainly by plummeting output in industry and tourism-related services. IT and financial services, in contrast, exhibited robust growth rates amid promotion of online payments and the emergence of new apps to meet demand for contactless services.

Construction, typically hiring migrant workers, took time to resume operations due to the lack of workers and/or protective materials. Manufacturing was also severely affected as the outbreak took place in the midst of the holiday season with workers away from their workplaces and, once the holidays were over, not able to return due to containment measures. The staggered outbreak across the world had a particularly adverse impact on global value chains, resulting in a series of disruptions in backward and forward linkages. Industrial firms have resumed production, but are operating at capacity utilisation rates that are 10 percentage points lower than normal. Smaller and private firms, due to their concentration in consumer goods manufacturing and exporting industries, and tourism-related services, are particularly hard hit, leading to a jump in urban unemployment. Migrant workers, who move to cities for temporary jobs, are not captured by such data, as they can hardly afford to stay in cities once they lose their job.

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Infrastructure investment and moderate monetary easing is supporting growth Government spending swiftly supported soaring public health material and equipment needs and covered the costs of COVID-19 treatment. This provided crucial relief, as out-of-pocket health costs are high in China, though reimbursement only applies for confirmed cases. R&D spending on medicine and vaccine development has also been stepped up. Firms in the most affected industries and regions benefit from VAT and income tax reductions and exemptions, and medical personnel from reduced income tax on overtime pay and in-kind benefits. Reduction or exemption of social security charges are even more important. While such tax and charge reductions ease the burden on the targeted groups, more systematic work-retention support is needed to prevent otherwise viable firms exiting the market. Frontloading of local government bond issuance will finance mainly infrastructure investment, which will hold up growth.

The coincidence of the virus outbreak and the Chinese New Year led to large liquidity injections early this year and these were followed by continuing liquidity support as needed. The monetary policy measures taken included the lowering of the reserve requirement ratio, reducing the interest paid on excess reserves, cutting the loan prime rate and rates on medium-term lending facility (MLF), and open market operations.

All these measures were effective in enticing banks to lend, as illustrated by robust credit growth. Some measures are intended to stimulate lending to smaller firms. Regional lenders, which tend to have a greater exposure to small firms and to tourism-related services, benefit from a greater reduction in the required ratio of deposits they have to hold with the central bank. In addition, the loan-loss provision coverage ratio for small and medium-size banks has been cut by 20 percentage points and the weight of financial inclusion in regulatory assessments raised. More recently, the central bank introduced a programme to purchase qualifying credit loans from small banks and set up a special purpose vehicle to lend to small businesses.

Moratorium of loan repayments by SMEs has been extended until end-March 2021.

Subdued domestic and external demand will weigh on the recovery With greater motives to save, lower consumer confidence and many export markets still weak, the recovery will be slow. There may be continued sporadic outbreaks in either scenario, leading to smaller-scale confinement measures, and activities involving physical contact or gathering in closed spaces will remain shut. With a moderate stimulus package of 3-4% of GDP, growth will be negative this year, notwithstanding the pick-up in infrastructure investment following a plunge. In the double-hit scenario, GDP growth will be a percentage point lower than in the single-hit scenario as subdued overseas demand weighs on exports and lockdowns constrain production. Those factors also curb growth in the single-hit scenario, albeit to a lesser extent.

Concentration of bankruptcies in the most affected regions and sectors could bring down lenders specialised in services to these regions and sectors and thus lead to the materialisation of systemic risk, spreading also to other regions. Heavily indebted private firms may also get to the brink of bankruptcy if debt moratoriums or restructuring are not extended. Allowing indebted, unviable state-owned enterprises and other public entities go bankrupt would sharpen risk perception. The lowering of the loan-loss coverage ratio for small banks also increases their vulnerability to serial bankruptcies of smaller firms. Bankruptcies would push up unemployment, both in urban areas and among migrants. Lockdowns in other countries may disrupt value chains, hitting China’s parts and components producers and assemblers, although their reliance on imported inputs is decreasing. A faster-than-expected recovery from the virus crisis in Asian countries would boost not only exports, as these are the fastest-growing markets, but also employment, as export-driven firms account for nearly a quarter of total employment. Moreover, as half of exports are delivered by private firms, an export recovery would halt the decline of the private investment share.

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More support to individuals and small firms hit by the outbreak is needed for a robust recovery The COVID-19 crisis should be used as an opportunity to initiate reforms to reduce the out-of-pocket share of health costs and strengthen social protection to encourage spending. The decision to forego a GDP growth target this year will allow greater focus on the quality of growth. Abandoning GDP growth targets for good would help to avoid incentives to pursue growth at any price and hence make growth more sustainable. Acceleration of the reform of the household registration system to grant access to public services to all would also work in that direction. Rebalancing from investment to consumption could continue only with those structural reforms. The private sector needs to be provided with a level playing field to expand investment opportunities and reverse the shrinking share of private investment. For efficiency, targeting infrastructure spending on projects with high social returns, such as urban transit systems or rural roads, is essential, especially if they help to mitigate climate risks.

OECD ECONOMIC OUTLOOK VOLUME 2020 ISSUE 1: PRELIMINARY VERSION Š OECD 2020