Assessing the Vulnerability of China's Economy to External Disruption

China is facing rising economic headwinds which are not only dimming its growth outlook but are also raising concerns about a potential recession. Domestically, continued COVID-19 flareups and ensuing restrictions under the government’s ‘dynamic Zero-COVID’ strategy are disrupting both the demand and supply sides of the economy. While the ongoing property downturn has left China without a key growth driver, and is also negatively impacting investment, industrial activity, and households wealth levels. This is all being compounded by an increasingly challenging external environment, with inflation running rampant in many countries, interest rates rising, external demand falling, and geopolitical risks increasing.

Our research suggests that several large economies will enter recessions by end the of 2022 or early 2023, and while a global recession is not our base case forecast, the risks are tilted to the downside. This does not bode well for China. Past experience suggests that its vulnerability to external disruptions rises in times of economic distress.

In this brief we explore how and to what extent the global economic slowdown – and, indeed, a potential global recession – would impact the Chinese economy; whether Chinese authorities would respond to this by implementing a sizeable stimulus package; and the factors that could drag the Chinese economy into a recession.

Insights for What's Ahead

• China is undergoing a period of economic distress and structural transformation that has increased its vulnerability to external disruption. The outlook for domestic demand remains muted given the government’s intent to continue pursuing ‘dynamic zero-COVID’. Against this backdrop, the international market has been a shining beacon for the Chinese economy: robust demand for China-made products has helped sustain economic activity to some degree over the past couple of years. But this growth driver has begun to fade as global growth slows down and several major economies edge into recessions. Not only will this constrain China’s ability to leverage the international market to offset the impact of its domestic headwinds, but if a global recession were indeed to materialize in 2023 – not our base forecast – the Chinese economy could be driven into a severe slowdown.
• The policy room for Chinese authorities to stimulate the economy in response to a potentially big external shock in 2023 is limited. A big monetary stimulus would exacerbate inflationary pressures and, against a backdrop of rising interest rates globally, depreciate the value of the RMB. But this is not the key issue. Rather, with weakening consumer and investor confidence and rising uncertainty about the outlook, the question is whether such stimulus would be efficiently distributed to support economic growth. Data suggest that this might not be the case: despite rising liquidity levels in the Chinese interbank market, growth in new loans to households and corporates is slowing down.
• Even with the risk of slowing global economic activity, we expect that China’s GDP will grow 5.3 percent in 2023 (based on official data), assuming a relaxation of the government’s ‘dynamic zero-COVID’ strategy. But gray swans can happen. A more severe than forecasted recession in the US and Europe plus a more deepening than currently expected downturn in China’s housing investment could lead the Chinese economy into a steep slowdown next year. It might even be worse than the impact of the pandemic in the first quarter of 2020 given that stimulus measures might not be as effective. Contingency planning against such events, however improbable they may seem, is good practice for MNCs operating in China.