People check in at an airport in Chongqing to fly home for the winter holidays. (Photo: chinadaily.com.cn)
The key presumption for the 2023 Outlook is that China will continue to relax its pandemic prevention and control policy. Major adjustments are already underway, with the National Health Commission issuing 20 easing measures in November and 10 further measures on Wednesday. In the near term, we expect China's COVID cases will increase further and mobility will stay subdued. Once the pressure on health care systems starts to ease steadily — likely in the second quarter of 2023, if not earlier, a more rapid return to normalcy and a rebound in mobility can be expected.
Consistent with what may be a relatively cautious adjustment path, we think China's economic activity will remain subdued in the first half of 2023 before picking up rapidly in the second half. We forecast that China's growth will rebound from 3 percent this year to 4.5 percent in 2023 and 6.5 percent in 2024, assuming a substantial reopening in the middle of 2023.
Loosening the restrictions on mobility will boost consumer confidence, likely including housing demand. Property policies have already eased substantially and are no longer constraining the recovery. Housing affordability has also improved, and households have increased savings and reduced their debt. Potential homebuyers that were held back by the COVID restrictions and concerns about creditworthiness will be encouraged to enter the market with both concerns assuaged. A strong property market recovery should therefore accompany the reopening.
Not much inflationary pressure
Now that China is starting to adjust, consumer inflation should begin to rise. China has been an outlier amid surging global inflation, with its headline consumer price index inflation remaining below 3 percent throughout 2022 and core inflation dropping below 1 percent in recent months. This, in our view, is largely due to slack in the labor market and low wage growth. China has very little "excess wage inflation", as measured by the gap between income and GDP growth. This could change once the economy enters a rapid reopening phase. In particular, labor-intensive service industries such as dining and entertainment will likely see a surge in job openings, bringing unemployment down while pushing wages up.
Our base case is that inflation will not surge to extreme levels. We forecast the annual average consumer price inflation will be 2.5 percent in 2023. Inflation should stay modest at around 2 percent in the first half of 2023 and rise to around 3 percent on the back of a service sector recovery and stronger household consumption demand.
Producer price inflation will likely stay low. The biggest driver for producer price inflation remains global commodity prices. Our global team forecasts that prices of key energy sources and metals will drop by around 10 percent year-on-year in 2023, which is likely to keep China's producer prices low. On the other hand, a recovery in China's domestic demand should provide some support for producer prices. We forecast that producer price inflation will average around 0.5 percent in 2023.
Policy stances
Both fiscal and monetary policy will likely maintain their easing bias in the near term. As economic activities will likely remain subdued during the first stage of reopening, sustained policy support will be needed.
We think the government will likely increase next year's official budgetary deficit slightly to 3 percent from 2.8 percent in 2022 and increase next year's local government bond quota to 4 trillion yuan ($573.6 billion) or more from 3.65 trillion yuan this year, to extend ongoing tax relief and fund COVID-related spending. We also expect the PBOC to cut the reserve ratio requirement further, by 50 basis points, in the first half of 2023 while holding its policy rates unchanged during the Fed's rate hike cycle.
Once China's economy begins to recover, we think fiscal policy will likely normalize faster than monetary policy. In the absence of an inflation problem, our base case is that the PBOC won't hike rates in 2023.
Ending renminbi's devaluation
The renminbi depreciated sharply in 2022 — almost 15 percent against the US dollar at its trough, and 5 percent against a trade-weighted basket of currencies. This was mainly driven by capital outflows rather than trade balances. The onshore bond market saw outflows of 0.5 trillion yuan in the first three quarters of 2022, from 0.6 trillion yuan of inflows over the same period in 2021. Meanwhile, China's current account surplus actually rose to an estimated 2.3 percent of GDP in 2022 from 1.8 percent of GDP last year, which represents a 0.7 trillion yuan increase in current account inflows.
Exports will face strong headwinds now that both the US and the European Union are expected to experience a recession. Our forecast is that exports will barely grow, by 1 percent, in 2023. We forecast that China's current account surplus will narrow to 2 percent of GDP in 2023 and 1.5 percent in 2024 from 2.3 percent in 2022.
We think the renminbi's depreciation is coming to an end and that it will likely appreciate again in 2023 and beyond. The exchange rate could still see a lot of two-way fluctuations between now and mid-2023 as the Fed keeps hiking rates and China's growth remains low. Once China's growth momentum picks up in the second half of 2023 and in 2024, we will likely see the return of steady financial market inflows into China. We forecast the renminbi will appreciate to 6.8 to the dollar by the end of 2023 and 6.4 to the dollar by the end of 2024.