China’s Covid Lockdowns Strain Economy and Global Supply Chains

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China's Covid lockdowns are putting the economy under strain and threatening to disrupt global supply chains, prompting Beijing to call for more contingency plans to deal with the risks.

Purchasing managers' indexes for March showed lockdowns in the technology and trade center Shenzhen and automotive city Changchun cut factory activity in the month. Services have also been hit hard as restaurants and retail shops close because of renewed restrictions and tightened social distancing measures. 

Supply chain scares are intensifying as Shanghai -- home to the world's largest container port -- battles mounting infections. Covid controls in the city are impacting operations and reducing efficiency at the port, while shipping giant AP Moller-Maersk has already shut some facilities in the city.

“Beijing's determination in maintaining its Zero Covid strategy for fighting the infectious omicron variant will very likely deal a severe blow to China's economy and will also have a global impact,” economists at Nomura Holdings Inc. led by Lu Ting wrote in a note. “Markets so far have underestimated the severity of the situation in China because it is difficult to fully reconcile and understand.”

The worsening situation puts pressure on policy makers to step up fiscal and monetary support. On Wednesday, China's Premier Li Keqiang reiterated China will stick to its full-year growth target of about 5.5% despite new challenges and increased risks. At a regular State Council meeting, he said stable growth should be a priority and contingency plans should be drafted to deal with possible greater uncertainties.

What Bloomberg Economics Says...

The economy took a hit in March. But the declines almost certainly understate the degree of the deterioration in business conditions. The April PMIs will most likely reveal a much more pronounced lurch downward. The data give a green light to more policy stimulus. 

Chang Shu, chief Asia economist, and David Qu, China economist

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Economists warn the situation could worsen in April, denting growth for the second quarter as uncertainty grows about the scope, severity and length of China's lockdowns. Areas covering roughly 30% of China's GDP are affected by the outbreaks, according to Goldman Sachs Group Inc. Natixis SA estimates a 1.8 percentage point cut to the first-quarter growth rate because of the Covid controls.

“As the Shanghai lockdown only happened in late March, economic activities will likely slow further in April,” said Zhang Zhiwei, chief economist at Pinpoint Asset Management Ltd. “The government has made it clear that the priority is to contain omicron outbreaks, which indicates the willingness to sacrifice growth in the short term if necessary.”

The central bank similarly vowed to provide more support to the economy in a separate statement on Wednesday. The People's Bank of China reaffirmed that it will step up the magnitude of monetary policy and make it more forward-looking, targeted and autonomous.

“With intensified headwinds to growth from local Covid outbreaks and policy makers sticking to full-year targets, we think the urgency for more policy support has increased,” Goldman's economists including Maggie Wei said in a report. The economists expect more central bank easing steps, including cuts to policy interest rates and the reserve requirement ratio. 

The latest blow to economic activity came Thursday morning, as government data showed manufacturing activity contracting in March for the first time in five months. It was an unprecedented fall, as the indicator had before now risen from February every year as people return to work and businesses start up again after the Lunar New Year holidays.

In Shenzhen, companies like Apple Inc. supplier Hon Hai Precision Industry, better known as Foxconn, temporarily shuttered during a week-long lockdown in March. And in Changchun, an industrial hub that accounted for about 11% of China's total annual car output in 2020, automakers like Toyota Motor Corp. were forced to close. 

Some businesses were able to resume work by adopting a so-called closed loop system in which employees were kept at factory locations and tested regularly. Still, small and medium sized companies took a big knock, and continued to contract in March, the PMI surveys showed.

The disruptions affected the “stability” of the manufacturing supply chain, said Zhao Qinghe, a senior statistician at the NBS, noting an index measuring delivery time of suppliers fell to 46.5, the lowest since February 2020. Some companies surveyed said there were “insufficient employees working in their posts,” he said, adding that firms also cited clogged logistics and extended delivery cycles. 

The damage to consumption could be deeper and more long-lasting than to production. Consumers are becoming “more cautious amid the renewed virus flare-up,” Julian Evans-Pritchard, senior China Economist at Capital Economics Ltd., wrote in a note. 

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With assistance from Bloomberg