The zero-Covid lockdown in Shanghai has repercussions for Chinese economic growth and political risk, and global supply chain disruption.
1) Economic hit
Shanghai accounts for about 17% of China's imports, 14% of its inbound investment, and 4% of its GDP.
The lockdown therefore constitutes another hit to Chinese growth, which is already slowing, as reflected in the contractionary 49.5 manufacturing purchasing manager index score in March.
This likely increases the need for another round of policy stimulus. Real interest rate of positive 1.4% implies room for monetary stimulus although fiscal deficit close to 7% of GDP implies less scope for much higher government spending.
More worryingly, it may also increase the risk of another regulatory swipe at private companies, which are called upon to do their bit for overall growth.
2) Political discredit
Much as the government, under the leadership of President Xi Jinping, takes credit for the successful control of Covid, it also presumably is damaged by perceived failures in Covid policy and the inaccessibility to fresh food in Shanghai (Chinese urban diets are generally less skewed to long-life, processed food than in developed markets) because of bulk transport and last-mile delivery disruption.
Slower overall economic growth, compounded by the zero-Covid lockdown strategy, is coming at an inopportune time as the National Congress of the Communist Party approaches, when Xi is expected to secure an unprecedented third term as General Secretary.
3) Global supply chain
Shanghai accounts for over 5% of global sea container and air cargo volumes and is 1% of global exports.
For most developed market economies, imports from China equate to about 2% of their GDP.
For a range of emerging market economies, imports from China equate to well over 2% of GDP. For Asian economies, in particular, imports from China are clearly deeply interconnected with their own manufacturing export supply chains. Consider Vietnam for example – often touted as an alternative to Chinese manufacturing, but with, at least for now, Chinese imports making up about 36% of its GDP.
China equities: Cheap valuation but a rare outflow
China equities (Shanghai Composite index) are down 13% ytd, similar to Korea (down 13%) and Taiwan (down 11%), but much worse than India (up 1%), let alone commodity exporters South Africa (up 13%) and Brazil (up 32%).
China looks cheaper than most Large EM peers in terms of PB and PE multiples relative to history. Trailing PB is 1.5x, an 8% discount to the 5-year median, and forward PE is 10x, an almost 20% discount.
China witnessed a rare monthly outflow in March, its first since September 2020.
It is tempting to attribute this to factors – which have been brushed aside hitherto – finally catching up with China portfolio allocation:
Crackdown on tech.
Real estate debt.
Broader macroeconomic slowdown.
Foreign policy tensions around Taiwan.
Key-person risk in Xi Jinping.
However, that may be too convenient a narrative. All of the other large Asia EM markets – Taiwan, India and South Korea – saw outflows, and across January and February too, not merely March. And the size of the outflows in those markets dwarfed those seen in China.
It is more likely that China saw net outflows for the same reasons as the rest of Large Asia EM, but it remains relatively insulated because of the need for most global funds to allocate more to China as its weight in global equity indices grows to match its share of global market capitalisation.
China's Shenzhen lockdown impact, March 2022