Longtime China watcher Andy Rothman is convinced that Beijing will abandon its strict lockdown policy and vigorously stimulate the domestic economy.
Andy Rothman has been closely involved with China for 40 years. As a diplomat, the American headed the Office of Macroeconomics and Domestic Policy at the U.S. Embassy in Beijing, where he was involved in the negotiations for China’s accession to the World Trade Organization in the late 1990s.
Since the turn of the millennium, Rothman has been looking at the People’s Republic with an investor’s perspective, first for the Hong Kong-based brokerage CLSA and since 2014 for the investment specialist Matthews Asia.
Today, he does not share the widespread pessimism about China. «I am convinced that China will continue to open up if we set the right incentives and guard rails», says Rothman. For investors, it’s worth sticking with it.
We receive dramatic macro data out of China. What’s your assessment of the current economic situation in China?
You have to focus on what’s happening with Covid in China, because that’s the determining factor for everything right now. Over the past forty years that I have observed China, first in the U.S. foreign service and then writing about the Chinese economy for investors, I have taken away two fundamental beliefs: The first is that the Chinese people are very resilient. And the second is that when it comes to economic policy, the government is generally pragmatic. They make a lot of policy mistakes, but they tend to course-correct and fix those mistakes after a while.
But that pragmatism seems to be lacking lately.
Yes, they haven’t been very pragmatic recently. Not so much on economic policy, but on dealing with Covid, which has determined where the economy has gone. Their Covid policy has worked well before Omicron swept across China in early March. Up until then, the economy had been quite healthy, it bounced back well after the first Covid wave of early 2020. I am not giving up hope that the government will return to pragmatism when it comes to dealing with Covid, which will then allow the economy to bounce back.
So you’re saying their Zero Covid policy has worked well until Omicron, but by sticking to it, they are making a policy mistake?
Yes, that’s a fair summary. I think though that the government has not been following a strict Zero Covid policy but rather a somewhat flexible zero tolerance policy. It’s not been the same policy all along, it’s been updated to circumstances. It was successful up until Omicron, they had far fewer deaths on a per capita basis than any other major country, and the economy did very well. But they were not prepared for Omicron in part maybe because of hubris about how successful they were before. And they made two big mistakes along the way.
The first is that they have not approved foreign developed mRNA vaccines for use in China, even though they are more effective than the vaccines that have been developed in China. This is puzzling because we know that BioNTech has licensed the vaccine to a Chinese company, Fosun, two years ago, and the government has approved Fosun distributing over 20 million doses of this vaccine to Hong Kong and Macao, as well as to Taiwan. They haven’t explained why they’ve refused to distribute it on the mainland, hence we can only conclude that this is a poor policy choice based on nationalism.
And the second mistake?
They focused their vaccination drive on the working age population, whereas most of the rest of the world initially focused on the more vulnerable, particularly the elderly. Beijing did a poor job of vaccinating their older people. As of March, only 20% of the population aged 80 and above in China were fully vaccinated with three jabs. Policy makers saw what happened in Hong Kong, where only 14% of the older people were fully vaccinated, and Hong Kong since February has suffered more than 8000 deaths, mostly among old people. But they haven’t been using the time that they created with lockdowns and mass testing to dramatically accelerate the vaccination drive for older people. This was the biggest mistake that the Chinese government has made.
Many observers say the government will be stuck with that policy at least until the 20th Party Congress in fall. They won’t be able to change tack without losing face. Do you agree?
I don’t think this is about losing face. There is no hard definition of the zero tolerance policy, they have been adjusting it all along. Nobody would criticize them for being smarter and more pragmatic. I think it’s about a genuine fear of what could happen to the older population. There have been studies that have forecast that as many as 1.6 million people over the age of 80 could die if they are not careful in how they manage Covid. What happened in Hong Kong has frightened them.
How do you see things playing out over the next months?
Recently, two vice mayors in Shanghai held press conferences, where they outlined a specific plan for lifting the lockdowns. They gave specific dates when shops could start to reopen, when the subway would resume, we have already seen the main railway station in Hongqiao open. I don’t think they would have made those statements if they were not planning on following through. So I am hopeful that this is a turning point in the realization on the part of the government that this lockdown approach can’t work for an extended period of time. It is devastating to the Chinese economy and to the social and mental wellbeing of the people.
And given that hope, you expect to see a strong economic recovery in the second half of this year?
That’s right. I think that if they return to pragmatism with respect to Covid, which includes dramatically ramping up the rate of vaccinations for old people, and easing lockdowns, then the economy will bounce back. I also expect a significant stimulus in terms of monetary and fiscal policy to kickstart that recovery. From an investor's perspective, two things will be important: This easing of monetary and fiscal policy will be coming at a time when the Fed and the ECB are tightening, and it will be coming at a time where valuations for Chinese stocks are really, really cheap.
Which policy levers will they pull to stimulate?
I’ve been hoping that they would pull a new policy lever, which would be direct assistance to consumers, who would then go out and jump-start spending. But my hopes are fading, because nobody is talking about it. So I think what they are going to do is the same kind of stimulus that they used to deal with the global financial crisis, a program which I have been referring to as the largest Keynesian stimulus since Keynes. On the monetary policy side, we’ve seen the first stages of interest rate cuts. We’ll see a little bit more of that, but more important than the rate cuts is the acceleration of credit availability. We’ll see a much more significant pick-up in the growth rate of credit into the economy as soon as the lockdowns are lifted.
Do you expect large-scale infrastructure and property investment?
An important element of the stimulus will be the property market. That was one part of the economy that was lagging last year, but one has to remember that this was a deliberate government policy. They wanted to promote consolidation, tried to weed out some risky developers, so they basically told banks to stop issuing mortgages. They have already reversed that policy, banks are now able to issue mortgages, and mortgage rates have come down. Cities for the first time in many years are allowed to put in place their own promotional efforts to jump-start new home sales.
What about infrastructure investment?
Yes, but on a significantly smaller scale than during the GFC. Infrastructure is always an important part of their stimulus policy, as it’s something that they know how to do, and China always has a lengthy list of shovel-ready projects. This time, it won’t be focused on bridges and airports, but more on things like upgrading the power distribution system to make it more amenable to feeding in from solar and wind or upgrades for infrastructure for electric vehicles.
How important will it be for the Party to show a strong economic recovery by the time of the 20th Party Congress?
There is no question that Xi Jinping and the rest of the Party leadership want the domestic environment to be good when they convene the Congress. But it’s not just about the economy for them, it will also be about public health. There will be a strong motivation to get Covid under control and the economy back on track and show a visible recovery by the time of the Congress.
You mentioned that Beijing will embark on fiscal and monetary easing, while the Fed has initiated a tightening cycle. To what extent does that create a problem for the People’s Bank of China as it could cause the RMB to devalue?
They have to take that into account, but they have the tools to manage the exchange rate. They are able to intervene, and there are still significant capital account controls. So I don’t think that represents a significant obstacle to the kind of easing that I’m talking about. Also, it’s worth noting that the PBoC doesn’t have to worry about consumer price inflation to the extent that the ECB and the Fed have to, because consumer inflation is not a problem in China right now. This is largely because they have mechanisms to mitigate the impact of higher oil prices on consumers.
Given the experience of the past months, is Xi’s position weakened?
The current situation with respect to Covid and the economy is a problem for all of the leadership in China. But if you are asking if this calls into question whether Xi is going to receive a third five year term, I’d say there is zero evidence to suggest that.
In the past few weeks, premier Li Keqiang was given a larger public profile again. What do you read into that?
In theory, Li is in charge of economic policy, and it’s unlikely that it’s a coincidence that his views on the economy have received more attention in the official media lately. In my view, this is a signal that the Party wants to return to pragmatism, because Li has been talking about getting people back to work. I’m hoping, and we should be able to see this within the next month or so, that this is a reflection of the Party wanting to communicate to entrepreneurs and consumers that they feel their pain and they are looking for ways to put the economy back on track.
Over the past 18 months, it was not primarily Covid that has spooked foreign investors, but the relentless regulatory crackdown against internet companies. What was going on there?
I think there have been two elements at play here. One is that the government has had valid objectives but has gone about pursuing them in a harmful way. These objectives are concerns about the same kind of socio-economic problems that we have to deal with in the West: Inequality of income and wealth, unequal access to healthcare and education, and on the business side some large firms using anti-competitive practices. The Chinese government apparently thought it was time to act. But they did a horrible job of communicating it both to their own citizens and to the investment world, and they went about it in a chaotic and uncoordinated way.
Is the worst of that crackdown over now?
As I’ve mentioned, the Chinese government is generally pragmatic but they often make mistakes, which they then correct. The Party leadership has acknowledged that they overdid it, and for the last six months or so, they have been saying that the future regulatory environment will be less volatile. Every couple of weeks there are more statements about this, most recently by vice premier Liu He. They are not saying that they are abandoning their objectives about reducing inequality, but they are saying that they have to do a better job of implementing so it doesn’t get in the way of entrepreneurship. China still is a very entrepreneurial place. Private enterprises account for about 90% of urban employment and all of the net new job creation, all of the wealth creation, all of the innovation.
What’s the second element at play?
The second element for foreign investors has been that we in the investment world haven’t succeeded in explaining what the government has been trying to accomplish here, and as a result many foreign investors had misunderstood this, believing that this was Xi wanting to roll back the market based reforms of the last decades.
Is that not exactly what this is?
I don’t think so. China has gotten rich over the last few decades only because the Party leadership has gotten out of the way and allowed markets to play the primary role. It’s just inconceivable that they would be so impractical as to say we’re going to go back to where we were 30 or 40 years ago. 1984, when I started working in China as a young diplomat, their per capita income was on the level of Haiti or Afghanistan.
You don’t see that these measures, like Xi’s Common Prosperity drive, are part of a genuine ideological shift, away from the entrepreneurial economy?
I would put it somewhat differently. I think that one of the reasons why they’ve driven so hard at these issues recently, was that they saw what was going on in the US: How problems like inequality, healthcare, education, housing, have become so severe there that it’s led to a deeply divided society and gridlock in the policy process. Chinese officials have been talking about Common Prosperity since Mao, and Xi had been talking about it since he became head of the Party. But I think the timing has been driven by looking at the US, and saying «We really need to get a grip on this before it’s too late».
Would you really say that the Party under Xi is, at its core, still defined by the kind of pragmatism that it was under Deng Xiaoping?
I believe it is, I hope it is. And we will have a much better sense of that in the coming months. It’s important to recognize that this has happened before. Since the reform period started, there have been some very hard times, there have been frequent policy mistakes, but the government has generally returned to pragmatism. So I’m looking for two signs to see if that’s still true. One, we’ve discussed, is how they will deal with Covid.
And the other?
That’s a niche issue, but important for investors. It’s the question of whether or not the 260 Chinese companies that are listed in New York are going to be kicked out. At its core, it’s a question about whether the Chinese government allows the inspectors of the U.S. Public Company Accounting Oversight Board to check the accounting workbooks of a handful of Chinese companies, selected as representative samples by the US side. By the end of this year they will report back to the Biden Administration and Congress whether or not these inspections have run according to the same process and transparency levels that have been in place in 25 other countries. This will be an opportunity for us to test whether the Chinese leadership is returning to pragmatism.
One more thing that has spooked investors was Beijing’s stance towards Russia given the war in Ukraine. What is the cost-benefit-analysis that Xi is making?
I think that the reaction by the Chinese leadership has been driven a lot by their perceptions of US policy towards China. They have been feeling over the last several years that Washington wants to contain China and limit its ability to get richer and stronger. That was making them feel trapped. My view is that had the US approach to China been less confrontational over recent years, the Chinese position towards Putin might have been different. But we should also see what the Chinese leadership has done and not done. They have refused to criticize the invasion of Ukraine and the horrendous attacks on civilians by the Russian army, which in my view is horrible and a huge mistake on the part of China. But they have not given military or financial support to Putin, as US government senior officials regularly note. I don’t think they will violate the EU and US sanctions on Russia.
In the four decades that you have observed China, you’ve seen the entire development: reform, the hope of the 90s, China’s accession into the WTO. There was a time when people thought the West and China could have a true symbiotic relationship. Was it all one big illusion?
This is the fundamental question about how democracies deal with China in the coming years. I feel like I am in an increasingly small group of observers of China who feel that engagement over the last four decades has been constructive for us as well as for the Chinese people. And I’d say the evidence supports that. Sure, China has not lived up to all its WTO commitments, but, to be honest, there are very few countries that have. Since they have joined the WTO, US exports to China are up over 600%, compared to 125% to the rest of the world. General Motors sells more cars in China than it does in the US. Qualcomm gets two thirds of its global revenue from China. If that goes away, how will they invest in R&D? The vast majority of Chinese people lead a life which is better in material terms, in terms of access to education and healthcare, than their parents. So I think the biggest mistake that many people are making right now is not recognizing that this process of engagement – among governments, people, universities, investors, companies – has actually been pretty successful. Ask yourself: What would the counterfactual be? If we hadn’t let China into the WTO, if we hadn’t incentivized them to change their behavior in order to get the benefits of being part of the global community? What would China be like today? Would we be better off? Would Chinese people be better off?
What’s the way forward?
Thinking of the counterfactuals is important when we talk about what we should be doing next. There are a lot of things going on in China that are disappointing, some of which are truly awful. What can we do, as governments, as investors, that will incentivize the Chinese government to improve their behavior? Needless to say, we need to keep the guardrails in place, and one of those guardrails is the US 7th Fleet in the Pacific. But right now, I fear that the Biden Administration is disengaging, saying things like China can’t even talk with us about our new Indo-Pacific Economic Framework. This also puts a lot of pressure on other countries in Asia. The US is effectively asking the rest of Asia to take sides. I really believe that this is not the most constructive way forward. And to narrow this down further for investors: Sure, we can take our money and go home. But if we invest in China on an active basis, doing due diligence, selecting companies that do business in a way that is aligned with our values, I think we can make money for our clients and we can move the needle in a small way. If we go home, we lose our voice.
Why did the rift between China and the West actually happen?
There were early stages of this in the Obama Administration where there was frustration with how slowly progress was being made on issues that were important to the Obama folks. Having been in government, I empathize with this. When you are a political appointee with a time horizon of two to three years, you have a really short period of time to get stuff done. And the Chinese government says «Well yeah, we’ll be around for a long time». But the rift dramatically ramped up with the trade war and then when the Trump Administration politicized Covid. Again, ask yourself: If we hadn’t taken the engagement approach with China over the last four decades, what would China look like today? I fear that if we give up now, if we treat China like an enemy, they are likely to become an enemy. One of the problems we have is that not enough people in the West, especially in our government today, actually know any normal people in China. People who run small businesses. They are only familiar with government officials or think tank people who are basically speaking for the government, and not realizing that once you get to know average Chinese people, they are pretty much like us. Is trying to isolate them going to make things better or worse? I strongly believe that there is a lot of evidence that if we provide the right incentives as well as guardrails, China will continue to open up.