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China's Zero-COVID Stance Poses A Bigger Threat To Firms Than Inflation

This report does not constitute a rating action.

Chart 1


China's zero-COVID policy poses a greater threat to corporates than inflation. S&P Global Ratings believes the recovery among Chinese firms will be prolonged while the country struggles to balance growth goals with its stringent stance on managing the pandemic.

The effects pose a particular risk to sectors reliant on mobility and consumption. This includes business and consumer services, media, entertainment and leisure, real estate, and transportation cyclicals.

China stands out in its pursuit of zero-COVID. It also, unlike most countries, does not believe it faces a significant inflation problem, as indicated by two cuts to policy rates so far this year.

The upshot is that, while the rest of the world is fixated on inflation, China's focus can remain squarely on the pandemic. Yet, ever-more transmissible variants are colliding with its commitment to eradicate the disease from the country.

Most provinces have endured more severe outbreaks this year than during the pandemic's peak periods in 2020. It has taken them longer to recover as increasingly infectious COVID strains led to more days with high-transmission rates and more mobility controls.

While the economy staged a sharp recovery from the first COVID wave in 2020, the recurring cycles of outbreaks and lockdowns weighed on the country's fragile consumption and compounded its property crisis.

Chart 2


Government efforts to resolve supply-chain blockages have helped freight volumes normalize this year. However, personal mobility remains well below par--passenger volumes are down 25%-50% year on year.

Diminished mobility has impeded Beijing's ability to roll out stimulus. Although more stimulus is likely underway, and at a large scale, we expect its effectiveness to be substantially stunted as long as zero-COVID remains the country's core pandemic strategy.

Emerging Threat To Corporate Rating Momentum

Net rating actions in our China corporate portfolio have been negative since 2018, long before COVID became a factor (see chart 2). China's slowdown and its trade war with the U.S. had already tilted our rating actions in a negative direction. While rating momentum recovered quickly after the first pandemic peak in 2020, it plunged deeply into the negative again a year later as the country's property crisis took hold.

Rating actions stayed largely negative in 2022, with entities hit by the recurring toll of China's zero-COVID strategy. New, highly infectious strains in 2022 are triggering more, and longer, lockdowns this year. The effects of new measures often pile up before localities fully recover from prior measures, leading to cycles of outbreaks and lockdowns that hit economic activity.

As a result, the outlook bias in our Greater China corporate portfolio remains substantially negative at 11.3%. Downgrade risks are particularly concentrated within speculative grade, where we have negative outlooks on 45% of ratings, more than nine times the percentage of investment-grade ratings on negative outlook (see chart 3).

Chart 3


Sectors with the most negative outlook biases include business and consumer services, media entertainment and leisure, real estate, and transportation cyclicals (see table 1). They share one trait in common: their prospects rely on mobility and consumption, leaving them more vulnerable to the effects of China's zero-COVID measures.

Table 1

Ratings Outlooks Are Skewing Negatively On Entities Within Sectors That Rely On Mobility And Growth
Sectors Number of rated entities Outlook bias % Weight %
Automobiles/autoparts 13 0.0 4.7
Business and consumer services 5 (40.0) 1.8
Capital goods 19 (5.3) 6.9
Chemicals 16 0.0 5.8
Consumer products 18 (5.6) 6.6
Investment holdings 6 0.0 2.2
Forest products/building materials 4 0.0 1.5
High technology 16 6.3 5.8
Local government financing vehicles 7 0.0 2.6
Media, entertainment and leisure 9 (66.7) 3.3
Mining and minerals 24 8.3 8.8
Oil and gas 9 (11.1) 3.3
Real estate 51 (39.2) 18.6
Restaurants/retailing 8 12.5 2.9
Telecommunications 7 0.0 2.6
Transportation--cyclical 7 (28.6) 2.6
Transportation--infrastructures 20 (5.0) 7.3
Utilities 35 (2.9) 12.8
Total 274 (11.3) 100.0
Note: Data encompass our rated greater China corporates. Data as of Sept. 5, 2022. Outlook bias is calculated by subtracting negative outlooks from positive outlooks, and then dividing by the total number of outstanding credits. Weight is the proportion of rated entities in each sector among all the sectors. Source: S&P Global Ratings.

More Infectious Strains Drive More High-Transmission Periods

Although 2020 is often described as the peak of the pandemic, this year has turned out to be worse for China. Indeed, in just the first eight months of 2022, 18 Chinese provinces accounting for about three-quarters of the country's GDP and two-thirds of its population saw more high-case days than in all of 2020 (see table 2, in Appendix).

We define high-case days as those when total new cases exceeded 100 over a 14-day period, inclusive. By our observation, such periods have consistently triggered stringent lockdown measures in the affected area. As such, they can also be used as a quantifiable indicator of the presence of such measures in a given region.

One notable takeaway of this exercise is that more infectious COVID strains have driven dramatically more high-transmission periods in many provinces this year versus 2020 (see chart 4).

For example, Fujian's high-case days were 6.3 times that of 2020, followed by Guangxi (4.7x), Guangdong (4.2x), Shanghai (4x), Sichuan (3.2x), Zhejiang (2.9x), Shaanxi (2.9x), and Beijing (2.2x).

Chart 4


More Drag On Growth In More Places

More high-transmission periods have resulted in repeated mobility controls across the country. Unlike 2020, localities have been unable to rebound quickly this year, as reimpositions of lockdowns prolonged their recovery and weighed more heavily on their growth (see charts 5a and 5b).

As an indication, the negative correlation between provincial GDP growth rates and the number of high-case days rose to 0.6 in 2022 from 0.39 in 2020 (where a score of 1 shows a perfect correlation between variables, and a score of 0 shows no relationship).

Moreover, wealthier provinces saw weaker growth this year than in 2020 (see table 2), with the negative correlation between GDP per capita and provincial growth rates rising to 0.43 from 0.24. This implies that this year's lockdowns may have inflicted greater damage among higher-income population centers--areas more vital to the country's consumption and to many firms' sales.

The recent return of lockdowns in Shenzhen, Guangzhou, Chengdu, and Shijiazhuang suggests that these cycles and their resulting toll on firms and growth will continue so long as zero-COVID remains in place.

Chart 5a


Chart 5b


Longer Recovery As Mobility Fails To Bounce Back

In addition to weakening growth, a key challenge to corporate recovery this year is zero-COVID's continued drag on mobility. Using passenger volumes as an indication, mobility has weakened continuously in 2022, and remains 25% down year on year. This makes for a striking contrast to the V-shaped recovery in mobility in the second half of 2020 (see chart 6a).

Freight volumes recovered quickly in 2020 and 2022, as central and local governments quickly addressed supply-chain outages. This allowed for a stronger recovery in industrial output than retail sales for much of this year (see chart 7a).

Notably, passenger volumes appear to be increasingly taking on an "L" shape as zero-COVD continues. This does not bode well for sectors that rely on human mobility, as an "L" implies no recovery at all.

Zero-COVID Worsened The Property Crisis And Impeded Stimulus

Challenged mobility has held back deployment of government stimulus and compounded China's property crisis. We now expect property sales in the country to fall 28%-33% this year, almost double the drop in our previous forecast (see "China Property Sales Set To Drop By A Third As Mortgage Strikes Break Out," published July 26, 2022).

Chart 6a


Chart 6b


Chart 7a


Chart 7b


Lockdowns during the typical active project launch months of March-June further demotivated homebuyers already worried about pre-buying homes that may not be delivered. They also slowed approvals, delayed launches, and obstructed the construction of real estate and infrastructure projects.

Beijing's calls in the past month for more progress on stimulus deployment suggest the delay of related projects has become a big enough problem to concern central policymakers.

Indeed, although overall fixed asset investment (FAI) ticked up in the first quarter of this year on the back of early stimulus, it quickly descended thereafter, pulled down by the plunge in real estate FAI (see chart 7b). The synchronized weakening of both reflects worsening conditions in the real estate sector as well as the inability of stimulus so far to reverse this deterioration.

Zero-COVID Is The Threat, Not Inflation

In addition to fiscal stimulus, authorities have engaged in monetary easing, including cutting policy rates twice this year in the face of rate hikes across the U.S., Europe, and Asia (see chart 8a). This was a feasible policy option for China because the government does not view inflation as an overriding risk.

We forecast China's inflation to stay well within historical ranges, reaching 2.3% this year and 2.5% next year, then tapering off in 2024 and 2025 to 2.2% (see "Economic Outlook Asia-Pacific Q3 2022: Overcoming Obstacles," June 27, 2022).

For corporates, decelerating producer prices have led to a convergence of consumer and producer price momentum this year (see chart 8b), which will ease margin strains in the coming year. This implies that the greater threat to corporate outlook in the next six months will come from zero-COVID's hit on the top line, not inflation's hit on the bottom line.

Revenue Squeezed As Margins Improve

These factors are filtering into the revenue and margin projections in our rated China corporate portfolio (see charts 9a and 9b). We expect median revenue growth to drop to 5% this year, but the downward momentum will ease over the next two years to 4% in 2023, and 3% in 2024.

Margins should improve as firms better manage costs and as commodity prices ease amid slowing global growth (see "S&P Global Ratings’ Metal Price Assumptions: Prices Settle Lower As Slowdown Fears Grow," Aug. 8, 2022).

Median gross margins will likely recover from 2022's bottom of 23.4%, to 25% in 2023, and 25.5% in 2024. While positive, this may not be sufficient to offset the hit of unexpected outbreaks and lockdowns if zero-COVID remains the country's core pandemic strategy.

Chart 8a


Chart 8b


Chart 9a


Chart 9b


Muted Debt Growth To Ease Leverage

Amid the gathering difficulties, we expect corporates in our rated portfolio to keep debt growth at relatively low levels (see chart 10a). Median net debt among our rated Greater China corporates will likely grow 3.15% in 2022, down sharply from a 9.8% expansion in 2020. Their debt will likely continue to grow moderately, by 4.2% in 2023 and 3.5% in 2024.

Such moderation suggests leverage may ease even amid emerging strains on the top line. This would reverse the trend of rising leverage over the past four years. After their recent high of 4.6x in 2022, rated firms' median ratio of debt to EBITDA will likely ease to 4.5x in 2023, and 4.2x in 2024.

Chart 10a


Chart 10b


More Stimulus May Put More Resources To Less Effect

The government has launched stimulus or loosening measures since the end of last year (see chart 11). This shift came as policymakers examined the effects of previous tightening policies, and moved to stabilize growth in December at a policy-setting forum.

The government's actions have so far been unable to counteract the drag on growth exerted by the country's zero-COVID stance. While more stimulus is likely underway, and at a large scale, we expect mobility controls to substantially stunt the effectiveness of such measures.

For two years, China has consistently responded to outbreaks by ramping up lockdowns. There is little sign that policymakers will abandon this approach in their key upcoming gathering in October. Yet, zero-COVID has countered the effect of stimulus so far this year, and will likely do the same to new support next year if it remains China's core pandemic strategy.

Although many believe the government will begin relaxing its COVID stance next year, the timing remains highly uncertain. What seems clearer is that, as the country continues down the path of putting more resources to less effect, its economy and its firms will increasingly face a longer and more perilous journey to recovery.

Chart 11



Table 2

More High-Transmission Periods Translates Into Lower Growth
Breakdown of number of high-transmission days and GDP levels in Chinese provinces in 2022
GDP GDP Population GDP per capita GDP growth % Number of high-case days
Province Tril. RMB % total Mil. '000 RMB 2019 2020 2021 1H 2022 2020 2021 8M 2022
Guangdong 12.4 10.9 126.8 98.1 6.2 2.3 8.0 2.0 45 26 187
Jiangsu 11.6 10.2 85.1 136.8 5.9 3.7 8.6 1.6 27 30 30
Shandong 8.3 7.3 101.7 81.7 5.5 3.6 8.3 3.6 37 0 34
Zhejiang 7.4 6.4 65.4 112.4 6.8 3.6 8.5 2.5 29 20 84
Henan 5.9 5.1 98.8 59.6 7.0 1.3 6.3 3.1 32 13 51
Sichuan 5.4 4.7 83.7 64.3 7.5 3.8 8.2 2.8 28 0 90
Hubei 5.0 4.4 58.3 85.8 7.5 (5.0) 12.9 4.5 62 0 0
Fujian 4.9 4.3 41.9 116.6 7.6 3.3 8.0 4.6 19 21 120
Hunan 4.6 4.0 66.2 69.6 7.6 3.8 7.7 4.3 30 3 0
Shanghai 4.3 3.8 24.9 173.6 6.0 1.7 8.1 (5.7) 59 13 236
Anhui 4.3 3.8 61.1 70.3 7.5 3.9 8.3 3.0 30 0 20
Hebei 4.0 3.5 74.5 54.2 6.8 3.9 6.5 3.4 22 37 26
Beijing 4.0 3.5 21.9 184.0 6.1 1.2 8.5 0.7 52 0 115
Shaanxi 3.0 2.6 39.5 75.4 6.0 2.2 6.5 4.2 17 11 50
Jiangxi 3.0 2.6 45.2 65.6 8.0 3.8 8.8 4.9 28 0 18
Chongqing 2.8 2.4 32.1 86.8 6.3 3.9 8.3 4.0 29 0 7
Liaoning 2.8 2.4 42.3 65.2 5.5 0.6 5.8 1.5 0 16 38
Yunnan 2.7 2.4 46.9 57.9 8.1 4.0 7.3 3.5 10 98 0
Guangxi 2.5 2.2 50.4 49.1 6.0 3.7 7.5 2.7 18 10 84
Shanxi 2.3 2.0 34.8 64.9 6.2 3.6 9.1 5.2 3 0 0
Inner Mongolia 2.1 1.8 24.0 85.5 5.2 0.2 6.3 4.3 0 35 50
Guizhou 2.0 1.7 38.5 50.8 8.3 4.5 8.1 4.5 8 0 0
Xinjiang 1.6 1.4 25.9 61.7 6.2 3.4 7.0 4.9 28 0 0
Tianjin 1.6 1.4 13.7 114.3 4.8 1.5 6.6 0.4 0 0 62
Heilongjiang 1.5 1.3 31.3 47.6 4.2 1.0 6.1 2.8 44 44 52
Jilin 1.3 1.2 23.8 55.7 3.0 2.4 6.6 (6.0) 0 24 67
Gansu 1.0 0.9 24.9 41.1 6.2 3.9 6.9 4.2 0 6 49
Hainan 0.6 0.6 10.2 63.5 5.8 3.5 11.2 1.6 10 0 27
Ningxia 0.5 0.4 7.3 62.4 6.5 3.9 6.7 5.3 0 0 0
Qinghai 0.3 0.3 5.9 56.3 6.3 1.5 5.7 2.5 0 0 0
Tibet 0.2 0.2 3.7 54.6 8.1 7.8 6.7 4.8 0 0 17
Note: Data as of Aug. 31, 2022. High-case days are days when the trailing 14-day total gross new cases exceed 100 in a province. RMB--Renminbi. 1H--First half. 8M 2002--First eight months of 2022. Source: Wind, National Health Commission of China, National Bureau of Statistics, S&P Global Ratings.

Editor: Jasper Moiseiwitsch

Digital designer: Evy Cheung

Related Research

Greater China Country Lead:Chi-hao Chang, Hong Kong (852) 2533-3543;
China Country Specialist:Chang Li, Beijing + 86 10 6569 2705;
Research Assistants:Hiu Tung Chan, Hong Kong
XI Liu, Hong Kong

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